Understanding Renko Charts: Most of the market participants use candlestick charts to analyze the securities for a better view of price movements. Trading platforms provide various other types of Charting tools and the most famous amongst them is Renko Charts. Renko charts are among the other charts that have the advantage of simplicity and effectiveness.
This charting technique is based on price movements to identify trends and potential entry and exit levels. These charts are sometimes also referred to as Noiseless Charts.
Before using the Renko charts it is important to understand the meaning, working, formation, and strategies for easy spotting of buy and sell signals in securities. In this article, we shall be Understanding Renko Charts with examples for better understanding.
Table of Contents
What is a Renko Chart?
Renko charts are a type of chart that measures only the price movements of a security. The word Renko is derived from a Japanese word, renga, which means “brick”.
Renko charts are created from a series of bricks, which are determined by fluctuations in price rather than time intervals. A new brick is created when the price moves over a pre-specified amount, and each brick is positioned at a 45-degree angle up or below to the right of the prior brick. The brick placed upside is colored green and a down brick is typically colored red.
Understanding Renko Charts
Renko charts filter out all small movements and help market participants to more clearly see the price movement to capture bigger trends but the drawback is that some price points are lost due to the brick construction. It uses only the closing price of security for a specific charting time frame chosen.
The construction of renko charts includes selecting the box size that represents the magnitude of price movement.
Rules to consider on brick placement:-
- Bricks are always formed with their corners touching.
- There can only be one brick in one vertical column.
Calculation of Bricks
It is based on two values:-
- Average True Range(ATR):- It uses the values generated by the ATR indicator. The ATR is used to measure the volatility of a security, in which the ATR automatically determines a valid brick size. It generally calculates the ATR value on the candlestick chart and then it uses this value to define brick size.
- Traditional value:- It is defined by a user as pre-defined as the absolute value for a brick size. New bricks are only formed when price movement is at least as large as the pre-defined brick size.
For example, imagine setting the brick size by 10 points. Assume the security is trading at Rs 100, if the price moves up to Rs 110, a new upside brick is drawn. The brick will only be formed once the price closes at Rs 110.
Apart from the traditional way of selecting the brick size, it can also be selected by considering the average true range(ATR). ATR is a measure of volatility, therefore Renko charts based on ATR will use the fluctuating value of ATR as the box size.
Types of Bricks
There are different types of bricks formed on the Renko charts.
- When the bricks are formed above the previous brick, it is considered an up brick.
- When the bricks are formed below the previous brick, it is considered as a down brick.
Strategies using Renko Charts
Understanding Renko Charts as an action of price analysis helps to build strategies by the common practices employed in conventional price chartings.
- Support and resistance
The renko charts depict the momentum with key support and resistance levels, which helps traders spot correct entry or exit opportunities.
When bars of the Renko chart retest at the same price levels over a period creating a hurdle for price movements, it acts as a line of support and resistance.
In a range-bound market, traders can trade by placing a buy at support and exiting at the resistance level for a long position and the short position by placing a buy at resistance and exiting at support levels.
This can be followed until a price breaks above or below the resistance or support levels.
- Breakout Strategy
Catching the trend is important to capture more returns in security in the right direction. Breakouts occur when the price of a security breaches any of the key price levels.
The bars of the Renko chart help us to spot trends with its noise-less formation, but to avoid the false signals of trend formation, watching out for breakouts at key levels is important.
When the downtrend is expected to pause due to a concentration of demand it is considered a zone of support. Here traders can look for the breakout, where if the bars are formed below the line of support traders can enter a short position for further downside till the next support level is reached.
When the uptrend is expected to pause temporarily due to a concentration of supply, here, traders can look for the breakout, where if the bars are formed above the line of support, traders can enter a long position for further upside till the next resistance level is formed.
- Renko bars with moving average
A Moving average is one of the technical indicators used to understand momentum present in security. Moving averages plotted on a Renko bar chart help traders spot trends for a good entry.
When the bar of the Renko chart closes above the moving average, it indicates a strong momentum in the upward direction. Here traders can enter a long position in a security. The moving average also acts as a line of support to push the prices higher, and when the bar closes below the moving average, the position can be closed.
When the bar of the Renko chart closes below the moving average, it indicates a strong momentum toward the downward direction. Here traders can enter a short position in a security. The moving average also acts as a line of resistance to pull the prices lower, and when the bar closes above the moving average, the position can be closed as a sign of reversal.
- Smaller price moves are filtered to create a cleaner and noiseless chart.
- Support and resistance levels are easy to identify.
- The current price direction is determined based on the recent brick color.
- The optimal brick size is determined per the trader’s understanding of a chosen time frame.
- In Renko charts, smaller price movements are missed.
- The brick size calculator may provide an optimal brick size for past data, but that brick size may not be ideal for future price data.
- The major drawback is some strategies like scalping may not work with Renko charts as OHLC is not defined.
From the above learnings, Renko charts are a great charting tool traders should add to their analysis for noiseless trading. Some of the drawbacks may result in false signals so it is preferred to always have a confirmation to the trading entries generated.
Renko chart formation is a unique and clear Understanding Renko Charts and its strategies and backtesting with proper risk management enhances traders’ use of Renko bars for profitable trades in the long run.
Written by Deepak M
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