Things You'll Need:
- charting software
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Step 1
Obviously this process will produce bigger losers than winners and cause you to lose overall in your account. To be successful in any type of trading, we want small losers and larger winners, but how can we overcome the fear that makes us take profits early in a winning position? Market "noise," or minor fluctuations, trigger the fearful response in traders that causes them to exit otherwise profitable positions. One way is to use a system of charting that filters out most "market noise."
Enter Renko charts. Renko, originating from the Japanese word Renga meaning brick, offers a simpler view of the trend and allows traders a clearer view of the price action as well as support and resistance. The nice thing about Renko is that it can be used for charting any market, equities, futures, forex, or commodities. It ignores time and only focuses on the price action and trends. -
Step 2
As you can see from the picture above, Renko charts are constructed by use of red and green "bricks" or "boxes". The first step to constructing a Renko chart is to select the size for each box. For instance, if you are trading Apple stock, you could make the brick settings $2.00 for each brick. If the price moves up by $2.00, you would see a new green brick formed to the right and higher than the previous one. As price continues to move up, another green brick will be formed only if price advances by a full $2.00. If price reverses by the size of two bricks, in this case $4.00, then a red brick will signal a reversal and time to exit the trend.
An easy system to follow is to trade in the direction of the trend, and exit when it reverses. Support and resistance levels are easily seen on Renko charts. The thing you have to remember though is that the reversal signal will be when price moves twice the size of the bricks in the opposite direction. If you do not want to wait for a $4.00 reversal in Apple, you could make the bricks smaller. Experiment with your security to see the best settings for your risk management rules. A trend is defined by a minimum of three green bricks in a row for an uptrend and three red bricks in a row for the downtrend. You can enter the trade on the third brick. A reversal is noted by one brick of opposite color and signals your exit from the trade. -
Step 3
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 pre-defined amount. White bricks are used when the direction of the trend is up, while black bricks are used when the trend is down. This type of chart is very effective for traders to identify key support/resistance levels. Transaction signals are generated when the direction of the trend changes and the bricks alternate colors.
Basic trend reversals are signaled with the emergence of a red or green box/brick. A new green brick indicates the beginning of a new uptrend. A new red brick indicates the beginning of a new downtrend. Since the Renko chart is a trend following technique, there are times when Renko charts produce whipsaws, giving signals near the end of short-lived trends. However, the expectation with a trend following technique is that it allows you to ride the major portion of significant trends.
Renko charts can also be very helpful when determining support and resistance levels since they isolates the underlying price trend by filtering out minor price changes. Renko charts are also very effective at identifying key support or resistance levels.
