There’s a common complaint from the traders that they often exit from the profitable trades too early. The noise in the market often misleads you and result in exiting your positions quickly.
The entire problem would have been solved be if there would be a charting technique which could filter out market noise and you would have enjoyed the entire trend rather than exiting on minor corrections.
Well, there’s a tool named Renko chart which will solve your problem and today we’ll study in detail about what it is and how it works?
What is Renko Chart?
Renko is derived from Japanese word “Renga” or brick which ignores time and the movement is based solely on price. Renko charts filter out minor price movements, making them a preferred choice amongst many traders. Because some minor price fluctuations are filtered out, trends in price may be easier to spot, and the chart appearance is more uniform compared to candlestick charts.
Though time is not a factor for Renko charts, it may be a technique that should be used for swing or position traders rather than for intraday traders. The only parameter which must be determined here is the size of the brick itself. The bigger the size, the less movement a chart will show but there will be larger stops on the positions. On the other hand, if you take smaller brick size, the sensitivity to price movement will be too high and the reason for using the Renko chart will be lost. While there is no perfect setting, traders will often use 1% of the price of the stock as the setting on daily Renko charts. However, you need to experiment yourself and see which number suits you the best.
Brick calculation methods
There are two methods for calculation of bricks-
1. Average True Range (ATR)
You may simply use the values generated by the Average True Range (ATR) indicator. The ATR is used to filter out the normal noise or volatility of a financial instrument. The ATR method “automatically” determines a good brick size which calculates what the ATR value would be in a regular candlestick chart and then makes this value the brick size.
2. Traditional method
You may also your pre-defined absolute value for brick size. New bricks are only created when price movement is at least as large as the pre-determined brick size. The upside to this method is that it is very straightforward and it is easy to anticipate when and where new bricks will form. The downside is that selecting the correct brick size for a specific instrument will take some experimentation.
How to find trend direction?
We will simply incorporate 200 Exponential Moving Average (EMA) to find trend direction. Accordingly if the price is trading above its 200 EMA, then the trend is up. On the other hand, if price is trading below its 200 EMA, then the trend is down.
When to enter and exit the trade?
The simple logic to enter a stock is when a green brick appears. On the other hand, you will exit your position when a red brick appears. However, to make it more refined, you may use Renko charts 13 period EMA as a ‘trigger’ to signal an entry in the direction of the major trend. First, wait for at least two green bricks to appear above the 13 EMA. Then enter long on the appearance of the second green brick above the 13 EMA. The same logic will be on the downside.
Now the important question will be what will be your target? It’s simply a trend riding system and it will help you keep trailing your profits until a red brick appears in case of long and vice versa for the short position.
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Secret of predicting events based on Renko charts
People generally use Renko as trend riding system but truly speaking there are better charting technique like Heikinashi, which gives works better with regard to this. Don’t just trade based on Renko but understand what Renko has to offer actually?
Smart traders simply use Renko to predict the outcome of major events like election, budget, monetary policy etc where the noise in the market is highest.
The day prior to event will clearly reflect where the market will be headed. For example, say tomorrow the election is going to come out and you saw last brick to be green, you went long on the day of election. Similarly if there is red brick prior to the day of event, you may go short (with an accuracy of about 80%). Please note here we are using ATR value to be the brick size rather than giving our predefined absolute value.
Here’s a list of various events where Renko has informed us in the previous brick about the subsequent movement in the market-
Like their Japanese cousins (Kagi and Three Line Break), Renko charts filter the noise by focusing exclusively on minimum price changes. Renko bricks are not added unless price changes by a specific amount.
Traders who are unable to devote much time in analysing charts of various securities may benefit from scan section in StockEdge mobile app.
As with Point & Figure charts, it is easy to spot trend reversal and identify key support and resistance levels. Renko in simple words, say no to noise and yes to profits).