Contents
- Overview
- The Essence of a Renko Chart
- The Brick Size Calculation
- Which Time Frame Is Best for Renko Chart?
- Renko Trading Strategy for Producing Buy and Sell Signals
- Renko Trading Strategy: Making Use of Trendlines and Support/Resistance Levels
- Renko Trading Strategy: Putting Chart Patterns Together
- Final Thoughts on the Renko Trading Strategy
Overview
The purpose of this article is to provide insight into what a Renko chart is and how it might be helpful to you. In this article, you will learn how to leverage Renko chart patterns to create your own Renko trading strategy and to produce your own buy and sell signals.
The Renko trading strategy offers several benefits, such as increased trading precision, simplified chart-based analysis, and better awareness of price changes. The Renko trading strategy has certain unique characteristics that you may use to your advantage.
The Essence of a Renko Chart
In a Renko chart, time doesn’t matter because the focus is on how prices change. The Renko chart, which is made of bricks, is similar to the Point and Figure chart in many ways. Bricks are used in Renko charts, while X and O are used in P&F charts.
Renko is a chart that shows how prices have changed without taking time into account. For instance, the size of a brick is 5. It’s an hourly Renko chart, which means that at the end of each hour, bricks can be added. The price went up 20 points by the end of the hour. The chart now has four more blocks. An hour later, the price goes up 3 points, but no brick is added because the price change is too small. To make a new brick, it needs to go up at least 5 points.
With Renko charts, price noise is taken out so that traders can focus on the big picture.
The Brick Size Calculation
There are two methods or formulas for calculating brick size in charting software. The formation of Renko chart patterns is highly dependent on the method used to determine brick size. This has additional consequences when employing the Renko trading strategy.
Traditional
The brick size is up to the person using the Renko chart. It is set to a fixed value. Because the brick size does not change when using the Traditional method, there are no differences in how and when the charts are created.
Average True Range (ATR)
Uses the Average True Range value (preset = 14 bars) to automatically adjust the brick size to market volatility. The drawback is that if the ATR value changes, your chart must be repainted to reflect the new ATR value. To demonstrate, as of October 12, 2021, Tesla had a brick size of $20.31. Two months later, the size was now $58.69. As a result, the chart created at two separate dates differs substantially from one another.
With Renko Charts, Which Calculation Formula Produces the Best Results?
The decision is entirely up to you. To utilize a fixed value for the brick size or to use ATR to compute the brick size on the fly is a matter of personal preference. Due to the fluctuating volatility, I find it confusing when the chart is redrawn and looks different every time. Consequently, I personally prefer the Traditional method.
Which Time Frame Is Best for Renko Chart?
A Renko chart has a time axis at the bottom, but there is no set limit on how long it takes for a Renko block to form. It all depends on how volatile the price of the asset is and what size bricks you set.
In fact, when you choose hourly for the timeframe and 10 for the brick size, the chart just checks the price every hour. A brick may be created if the price goes up or down by more than 10 units. On the other hand, if the change in price is less than 10, no brick is made. Remember that you can only put a brick diagonally above or below the one before it.
This is a matter of personal preference and trading style. For the SP 500, I favor the hourly and daily Renko charts.
Renko Trading Strategy for Producing Buy and Sell Signals
In my opinion, the best or most effective Renko trading system that generates consistent buy and sell signals is one that takes into account support and resistance levels, trendlines, and chart patterns.
Support and Resistance
Renko charts are very visual and effectively highlight price support and resistance zones. It is common practice for traders to mark a support zone by drawing horizontal lines just above the bottom brick of a declining trend, with a break above this level signaling the end of the slide. So, the fresh upswing signals the buy entry point.
On the other hand, if the price spikes and then breaks the horizontal line to the downside, this indicates a false breach of the support level and suggests further weakness is likely in the future.
Trendline
Resistance and support trendlines can assist in establishing entry and exit points by linking previous highs and lows. The notion is similar to that of horizontal support and resistance levels.
Trendlines are simply diagonal lines that represent a price range or trend. These lines track the price movement in an attempt to provide traders with a rough idea of how high or low the price may go in a particular timeframe. When the price rises, so does the trendline. When the price falls, so does the trendline.
Connecting the lows with a line when prices are rising results in an ascending trendline—an “uptrend.” A trendline can also be formed along the trend’s highs. This demonstrates the ascending angle, the strength of the price move, and the trend’s relative strength.
When the price falls, so do the highs, or lower highs. A descending trendline—a “downtrend”—is formed by connecting consecutive lower highs. A trendline created along the lows may also be used to show the angle of decline and the strength of the downward price action.
Downward sloping trendlines indicate that market players would rather sell an asset than acquire it. When there is a downward sloping trendline, you should avoid keeping a long position; a gain on a move higher is improbable when the broader longer-term trend is negative. An uptrend, on the other hand, indicates that demand for the asset is greater than supply, and it is used to indicate that the price is expected to continue rising.
Renko Trading Strategy: Making Use of Trendlines and Support/Resistance Levels
Trendlines and horizontal support and resistance lines are often combined to produce buy and sell signals. Entry and exit points, and especially a stop-loss plan, should be part of your Renko trading strategy in case the price reverses after a false breakout.
Let’s pretend we paid $168 per share for Johnson & Johnson stock in the following scenario: Previous chart patterns suggested that the stock may hit $185, so that’s where our focus went. The stock, however, only rose to $180 before turning back down. What should the stop-loss plan be after the stock price falls below $170? Include this in your Renko trading strategy. What course of action should we take at this time if we believe in Johnson & Johnson and want to hold the stock long-term?
We have a few choices here. Our personal risk tolerance will dictate the decision we make.
- We can avoid taking any additional action. Just follow the buy-and-hold strategy.
- Buy protective puts to hedge against additional stock price declines.
- Sell covered calls. The objective of selling covered calls is to generate income and, at the same time, provide a level of loss protection as the stock declines.
- Since the purchase price was $168, you may liquidate your stock and, ideally, turn a small profit or breakeven.
Divergence in Price and RSI on a Renko Chart
The RSI might be a useful indicator to utilize in conjunction with Renko Charts, but it might generate a buy or sell signal far too early in a strong trend.
The following is an illustration of the divergence between stock prices and the relative strength index (RSI). However, while divergence is a respectable technical analysis chart pattern, it is not always 100 percent accurate. On the left-hand side of the chart, you can see that the stock price has continued to rise despite the fact that the RSI has reached lower highs.
In this scenario, it is clear that the divergence pattern between the stock price and the technical indicator cannot be the primary factor influencing the decision-making process. Support, resistance, and trend lines should all be applied to the chart as part of the decision-making process when making trading decisions.
As seen in the example below, divergence in the RSI indicates potential weakness in the S&P 500 index as the index has continued to rise from 3,500. The divergence, however, emerges too early in the uptrend’s progress. Up until it hit 3,850, the index showed no signs of easing.
Renko Trading Strategy: Putting Chart Patterns Together
Uptrend and Downtrend Trendlines
Trendlines are a basic tool that may be used to judge the overall direction of a certain market, but they may also be used by traders to anticipate regions of support and resistance.
Technical traders pay special attention as the price approaches a trendline, since these locations frequently play a significant role in deciding the price’s short-term direction. As the price approaches a key support/resistance level, one of two outcomes is possible: The price will either bounce off the trendline and continue in the previous trend’s direction, or it will go through the trendline, indicating that the present trend is reversing or weakening.
Double Bottom or W Pattern
W-patterns and other Renko chart patterns can help you make better judgments and generate greater profits. Using Renko charts, keep an eye out for the W pattern, as it often signals a reversal in trend and potential profit.
For traders, a double bottom on a Renko chart pattern could mean that prices could go up. On the chart, the pattern appears as a “W” formed by two parallel troughs. The first dip is the instrument’s previous trend low, while the second trough is the new trend low. There is a high in the middle of the two low points, suggesting an upward potential. Traders recognize a double bottom when price action bounces back up from a second low point in the pattern. When the price breaks above the pattern, it is seen as a bullish sign.
Exxon Mobile (XOM)
By early 2021, Exxon Mobil’s chart displays a textbook illustration of a powerful W pattern. The stock price of Exxon Mobile has risen substantially since then, as everyone knows.
BP Plc (BP)
The breakdown in the BP stock price after it broke through significant multi-bottom support at $37 is shown here as an example. The W formation at $22 was followed by a failed recovery. After breaking below the $22 support line established by the W pattern, the share price dropped further. The stock continued to decline until it reached $15, when it encountered buying interest.
Triple Bottoms – A TESLA Example
When price makes three successive lows at about the same level, a technical analysis known as a triple bottom chart pattern is formed. Sellers have sought to drive the price lower, but strong buying interest has prevented this from happening. See the triple bottom chart pattern below. If this pattern holds, it may indicate that the asset’s price will reverse, and the uptrend will pick up speed.
Double Top or M Pattern
Double top (also known as a M pattern) is the reverse of double bottom (also known as a W pattern). Strong bullish signals come from the W pattern, while bearish ones come from the M pattern. The double top chart pattern is widely used to forecast reversals in trends.
It’s spotted when the asset’s price makes two successive highs at around the same point. As the price of the asset fails to rise beyond the prior peak, this formation is interpreted as an indication of a bearish reversal. Two peaks are joined by a trough to form the double-top chart pattern. The peaks represent a price barrier that the asset’s value encounters with difficulty. The “neckline” is the trough between the two peaks, and a price drop below it is interpreted as a confirmation of the reversal pattern.
A double top typically follows an uptrend and indicates that purchasers have become exhausted. Sellers will seize control of the trend and drive the asset’s price lower, while buyers are unable to drive the price higher.
Head and Shoulders
The Head and Shoulders pattern is a popular bearish pattern in charts, typically indicating a reversal in an uptrend. A bullish reversal signal, the Inverse Head and Shoulders pattern forms at the bottom of a downtrend.
A head and shoulders pattern is one of the most reliable signs that a trend is about to change. It helps traders pinpoint when they should enter and exit the market. It consists of the three simplest elements:
- A peak on the left
- A higher top (the head)
- A lower right top (the shoulder).
With this information in hand, you should be able to make informed decisions when trading.
The neckline is defined by a line that runs between the two valleys on either side of the head. When this line breaks down, it completes the pattern and gives the signal to sell. The neckline can be slanted either way, but the pattern loses strength if it rises in the same direction as the uptrend. After a price break of the neckline, a retracement to test the neckline is common. This is a second chance to get in to sell.
Inverse Head and Shoulders
The opposite of Head and Shoulders is Inverse Head and Shoulders. In a downtrend, a triple bottom is formed when a lower low is followed by a higher low. The result is three successive lows. The lowest point of the middle dip, which is the head, is lower than the dips on either side, which are the shoulders.
In other words, the Inverse Head and Shoulder consists of the basic 3 elements:
- A trough on the left
- A lower low (the inverse head)
- A higher right low (the inverse shoulder).
A line that passes between the two peaks on either side of the head defines the neckline. When this line breaks to the upside, the pattern is complete, and the buy signal is given. The neckline can be inclined in either direction; however, the pattern loses strength if it slopes in the same direction as the downtrend. After a price breach of the neckline, it is common for a retracement to test the neckline. This is a second opportunity to buy.
The S&P 500 index rose from 4,100 to 4,500 with help from the W pattern and the inverse head and shoulders pattern, as seen in the following example.
Final Thoughts on the Renko Trading Strategy
When making trading decisions, a solid Renko trading strategy takes into account the Renko chart patterns, trendlines, and support and resistance levels as a whole. Renko chart patterns are a unique way to find price trends and can give traders useful information, like a better understanding of market volatility and the ability to predict possible reversals. Renko charts provide powerful patterns that may help traders make better decisions.
Discover three main advantages of these charting techniques:
- Increasing the accuracy of trend tracking,
- simplifying the identification of support and resistance levels, and
- reducing market disruption.
Renko chart patterns are time-tested and dependable, and they provide a simple yet effective way of analyzing market trends. By depicting price movements in uniform-sized bricks, they reveal trends and support and resistance levels that other charts may not.