Combining Trend Indicators for a Lower Risk Entry
A few years ago, a friend introduced me to the Heikin-Ashi indicator. Pairing it with the GMMA indicator resulted in a complementary combination useful for identifying a good low risk entry into a trend. Like the glaze on a donut or freshly frothed milk on a coffee, it just made what was already good even better.
Let me introduce you to GMMA’s new found friend, the Heikin-Ashi indicator.
Heikin-Ashi means average bar in Japanese. A Heikin-Ashi candle looks very similar to the traditional Japanese candle charts most readers are used to. The traditional Japanese candles use actual price to plot the open, close ,high and low of each candle while Heikin-Ashi candles use an average of price from previous sessions to plot the open, close, high and low of each candle. By using average price, volatility is smoothed out and false signals are avoided, particularly when it comes to identifying trend.
Figure 1: Traditional Japanese Candle Chart
Figure 2: Heikin-Ashi Candle Chart
Notice how the Heikin-Ashi chart appears smoother. An uptrend appears more obvious on the chart. Within the middle section bounded by the vertical dotted lines, the traditional Japanese candles in Figure 1, are a mix of bullish and bearish ones. A trader following this chart might fear a reversal of price at any point where a bearish candle appears. This is not always the case. By referring to the Heikin-Ashi candles in Figure 2, we see the uptrend is still strong despite the appearance of bearish candles on the traditional Japanese candle chart.
Heikin-Ashi candles enable traders to identify a trend in a clearer way than traditional candles on a chart. Combined with an emerging short term GMMA, it can be a powerful combination to use in capturing a short-term leg of a trend or a much longer one depending upon the timeframe chosen.
Taken from one of my past FX trades, the following shows the use of Heikin-Ashi candles in my short-term trading. The concepts are also applicable to trading stocks.
A top down analysis started with the 4 hour timeframe on GBPNZD, Figure 3, where I identified a steady uptrend. The moving average lines of the long-term GMMA were well separated showing good support for the uptrend while the lines of the short-term GMMA were also separated. Both groups were moving in an upwards direction.
Opening the next time-frame down, the GBPNZD 1 Hour chart in Figure 4, we see separation of the moving averages in the long-term GMMA and also in the short-term GMMA. The blue lines of the short-term GMMA were starting to expand out and upwards after a short period of compression.
The 4 hour and 1 hour timeframes were in agreement with both charts showing a definite uptrend. It isn’t always easy to make a successful trade on using the GMMA indicator alone. The GMMA is a great way of seeing the bigger picture before adding other indicators to help manage the trade and the analysis in the correct direction.
For short-term FX trades, I like to use the Heikin-Ashi indicator to confirm trend direction on the same charts initially used for GMMA analysis.
In this GBPNZD trade, I was looking for green Heikin-Ashi candles to match the GMMA uptrends we saw on the 4 hour and 1 hour timeframes.
Focusing on the most recent candle on the GBPNZD 4 hour chart in Figure 5, notice it is the 3rd green candle in a consecutive number of green candles. This is a good signal.
On the 1 hour chart of GBPNZD, Figure 6, the most recent candle is also green in a long row of consecutive green candles.
Putting the general framework together we have:
(1) A GMMA uptrend on both the 4 hour and 1 hour charts.
(2) Green Heikin-Ashi candles signalling an uptrend on the same two timeframes at the time of our entry.
This increases the probability of trend continuing and decreases the potential of a trend dip or reversal. It is a possibility at any time, despite the GMMA lines looking widely separated at the time of entry.
A long trade was opened for an entry at 2.0236, a Traders ATR stop loss of 2.0221 and a high probability target profit of 2.0321 calculated by taking 75% of the 5 day Average Daily Range. Research has shown this calculated target profit has an 85% probability of being achieved.
Price moved upwards and the trade was closed at 2.0268 as marked by the star on the chart in Figure 7. A profit of 32 pips.
Over a couple of more hours, price did manage to hit the profit target at 2.0321. By that time, I had already called it a day and was happy with the profit banked in.
The GMMA indicator easily identifies the overall trend. When matched with Heikin-Ashi candles in the same direction over a number of timeframes, this combination signals a higher probability of trend continuation.
Additionally, the Heikin-Ashi indicator may prevent a high risk entry if the most recent candle signals the opposite colour to the analysed direction, an early warning of potential weakness in the GMMA trend.