We all are well familiar with candlestick charts. Candlestick charts are thought to be originated from Japan. But Japan gave us one more very useful chart type called Renko charts. Though not as widely used as candlestick charts, Renko charts are still very popular among the traders.
Construction of Renko charts
These are named ‘Renko’ after the Japanese word ‘renga’ meaning bricks, as the chart looks like a series of bricks. A new brick is added to the chart whenever price moves by a fixed amount. Bricks are added either up or down to the previous brick depending on the direction of price movement. Generally, up bricks are colored green while down bricks are colored red.
The major difference between Renko charts and candlestick charts is that the latter is dependent on both price and time while the former ignores time and focuses solely on price movements. To understand it more clearly see it this way. In a candlestick chart, a new candle is plotted every day, every hour or every minute depending on the time frame. But Renko charts are plotted only when price moves a certain amount in one direction or the other. This unique feature eliminates noise from the charts and makes it easier for traders to identify price trends and trading opportunities. Below is a sample chart of the S&P 500 from investing.com.
The amount by which price must move before a new brick is formed is called ‘brick size’ or ‘box size’. This box size can be set by the user to either a fixed amount or to the ATR (Average True Range) of the stock’s price. ATR is nothing but a measure of the volatility of an asset over a specific period of time in the past. Keep in mind that only closing prices are used while making Renko charts.
Let’s make all this more clear with the help of an example, assume a stock is trading at $100 and has a $1 box size. If the price moves up to $101, a new brick will be drawn. That brick will only be drawn once the price closes at $101 or higher. If the price only reaches $100.50, a new brick will not be drawn. Once a brick is drawn it is not deleted. If the price rises to $102 or higher (and closes there), another brick will be drawn. Renko bricks are not drawn beside each other. Therefore, if the stock drops back to $101 a down brick is not drawn next to the prior up box. The price would have to drop to $100 for a down brick to appear below the prior up brick.
How to use Renko charts for trading?
Below are some proven ways in which Renko charts can be used for Trading:
Identifying the trends.
Due to less noise, Renko charts make it easier for traders to identify the trends. Traders can simply base their trading decisions on the formation of a number of consecutive red or green bricks. For example, you can decide to go long whenever three green bricks are formed consecutively and ‘stop and reverse’ the position whenever three consecutive red bricks are formed (see below figure).
Use in conjunction with other indicators
You can also apply other indicators to the chart and then create a trading strategy. For example, buying when the 8-period moving average crosses the 25-period moving average from below (bullish crossover) and selling when the 8-period moving average crosses 25-period moving average from above (bearish crossover). Remember that these are just examples. You have to find what works best for you and build your own strategy.
Identifying supports, resistance, and other technical patterns.
Renko charts not only help in identifying the trends but also makes identifying technical patterns a lot easier than the bar or candlestick charts. Since all the noise is filtered from charts, traders can identify not only simple supports and resistances but also more complex patterns such as head and shoulders, double-tops, double-bottoms, channels, triangles, Elliott waves, etc. very easily.
Also Read: Price action trading explained for Dummies
Drawbacks of Renko Charts
- Renko charts ignore time completely. This can lead to misunderstandings and false impressions in the mind of traders. For example, a stock which is stuck in a range for a long period of time may be represented with a single box. This can obviously be misleading for trading.
- Only closing prices are used in charts. Highs and lows are ignored. Although this helps in eliminating the noise, a lot of important information is also wiped out. That’s why relying solely on Renko charts for trading can be risky.
Renko charting is a great tool that can be harnessed for profitable trading. When used wisely, it can play an important role in a trader’s arsenal. However, just like anything else, it should also not be misunderstood as a holy grail. The key is to experiment and find out for yourself, how and where they can fit into your trading strategy.