ASX Education – Renko Charts

Renko charts are non-time based charts that are only concerned with price movement. Renko charts are "time independent" charts that do not have constantly spaced time axes. They are named after the Japanese word for bricks or "renga". Here is a Renko chart of the S&P 500 this morning which has just ticked a sell signal: A Renko chart is constructed by placing a ‘brick’ in the next column once the price surpasses the top or bottom of the previous brick by a predefined amount. You could use a fixed movement in cents, or percentage, but a more dynamic and popular technique is to use a number of ATR (Average True Range) for each brick, say a move of 1 x ATR. The Average True Range in simple terms is the average range from top to bottom that the price is trading each day averaged over the last 14 periods. So the daily ATR for BHP is the range it has traded in, from top to bottom, each day for the last 14 days, averaged. At the moment it is moving 71.5c a day from top to bottom. So back to Renko charts. If BHP moves more than 71.5c above the top of the last brick or 71.5c below the bottom of the last brick a new brick is plotted. So the price has to move more than the Brick Size (1 ATR) above the top or below the bottom of the last brick on the chart, before a new brick is added in the next chart column. Hollow White bricks (or blue bricks on our charts) are used when the direction of the trend is up, while solid black (or yellow) bricks are used when the trend is down - much like candles. Only one type of brick can be added per time period. Bricks are always with their corners touching and no more than one brick may occupy each chart column. Note - Prices may exceed the top (or bottom) of the current brick without a new brick being added because new bricks are only added when prices completely "fill" the brick. For example, for say a 5c chart (if 1 x ATR is 5c say), if prices rise from 98 to 102, the blue brick is plotted that goes from 95 to 100 BUT the blue brick that goes from 100 to 105 is NOT DRAWN until the price hits 105. Until then the Renko chart will give the impression that prices stopped at 100. Don’t worry if I just lost you. The "Average True Range (ATR)" method is the most popular, using the value of the ATR indicator to determine the brick size. You can use a fixed number of cents but the ATR indicator adjusts the significance of the brick depending on the volatility of a stock rather than applying the same rules to a boring stock as a volatile stock. The ATR method  "automatically" finds relevant brick sizes regardless of the value of the stock selected. The average true range over 14 days (or weeks) is the default value for Renko charts. Interpretation – For our charts, Blue bricks are bullish, yellow bricks are bearish - that's the simplest interpretation of Renko charts. Renko charts are good for identifying trends and trend direction because they screen out moves that are less than the brick size. Like all non-time based charts, they get rid of the noise. Consequently, trends are easier to spot and follow. In order to avoid whiplash periods, some traders will wait until 2 or 3 bricks appear in a new direction before going with the new trend and taking a position. If you were using 1 x ATR bricks obviously a change of trend showing two yellow bricks after a series of blue bricks (an uptrend) would suggest the stock has moved 2xATR which is a common stop loss setting (a fall of 2xATR). So the Renko chart can rather neatly highlight when you should sell on a stop loss (two yellow bricks in a row). Or you could set the brick size to 2xATR and sell when one brick ticks in the opposite direction. Renko charts are also effective for identifying key support/resistance levels. Trading signals are generated when the direction of the trend changes which is apparent when the bricks change colours. The benefits of a Renko chart:

• Simple - Patterns are more clearly identified.
• Trading signals like trend changes and line breaks are easier to spot.
• Less noise.
• Charts much easier to read.

Here is the APT Daily Renko chart using 1x Daily ATR bricks: Here is the Telstra daily Renko chart using 1x Daily ATR bricks: As always - it's a lot easier in hindsight. Success in trading is a combination of things - getting the trend right, the trend continuing (out of your hands) and using a time period that lets your profits run without whipping you in and out on small movements. For long-term investors, the tendency is to push the time period out - from Daily to Weekly, with the bricks representing 1xATR over 14 weeks not days. It is obviously a bigger number when calculated weekly so bricks are less frequent but you get fewer signals and it identifies the bigger trends (it can also indicate them a long time after they started which means the bigger the brick size setting the later you trade on a change in direction). Here's the Renko chart of the ASX 200 showing a bar every time it moves 1 x the daily ATR (currently 90 points) – you can see the recent peaks and troughs more clearly. So you might have a rule of thumb that is a stock or an index changes direction of at least two bricks (2x ATR – a standard stop loss size), you sell or buy.

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A BIT MORE TECHNICAL EDUCATION - PENNANTS Here is a standard candle chart of the ASX 200. As you may be aware we have been drawing our amateur support and resistance lines at the recent short term high and low and suggesting that we are waiting for the market to break up through resistance or down through support and that that would indicate the next trend. Another way to do that is to draw a "Pennant" on a chart as I have done on the ASX 200 chart below. The Pennant is much the same as the support and resistance lines but rather than draw them horizontally you draw them through the peaks and troughs of the price and in so doing form a "Pennant" and then the suggestion is that you buy if it breaks out of the Pennant to the upside and sell if it breaks out of the bottom of the pennant. Pennants are formed when there is a large movement in a stock – called the flagpole – followed by a consolidation period with converging trendlines – as in the ASX 200 chart above. The pennant is usually followed by another breakout in the same direction as the first flagpole, and this forms the second part of the flagpole. You can see those on the ASX 200 chart above – two 'flagpoles' after the March 24 low. It is also usual for the breakouts to occur on high volume and the consolidation periods to see volume drop away before picking up again on the breakout. There are different pennants and different entry and exit points. You can Google about pennants – this is from Investopedia on how to trade pennants: "Many traders look to enter new long or short positions following a breakout from the pennant chart pattern. For example, a trader may see that a bullish pennant is forming and place a limit buy order just above the pennant's upper trendline. When the security breaks out, the trader may look for above-average volume to confirm that pattern and hold the position until it reaches its price target. The price target for pennants is often established by applying the initial flagpole's height to the point at which the price breaks out from the pennant. For instance, if a stock rises from $5.00 to $10.00 in a sharp rally, consolidates to around $8.50, and then breaks out from the pennant at $9.00, a trader might look for a $14.00 price target on the position - or $5.00 plus $9.00. The stop-loss level is often set at the lowest point of the pennant pattern, since a breakdown from these levels would invalidate the pattern and could mark the beginning of a longer-term reversal. Most traders use pennants in conjunction with other chart patterns or technical indicators that serve as confirmation. For example, traders may watch for relative strength index (RSI) levels to moderate during the consolidation phase and reach oversold levels, which opens the door for a potential move higher. Or, the consolidation may occur near trendline resistance levels, where a breakout could create a new support level." [activecampaign form=75]