Trading Systems Series

THE RENKO CHART Renko charts have their origins in the early days of the markets being traded in Japan, some 140 years ago and were first introduced to the West by Steve Nison in his book Beyond Candlesticks in 1994. The actual word Renko is derived from the Japanese word renga, which means bricks. When you see a Renko chart it will become obvious why it is derived from bricks. Renko charts are price charts with rising and falling diagonal lines of boxes that are either filled or hollow. With their equal brick size and with their relentless trend detection ability, the Renko charts convey equilibrium where there is little. The Renko s stairway design takes a lot of the noise out of the market. 1

What makes Renko different from Bar or Candlestick charts? Renko is only concerned with price movement, unlike Candlesticks or Bars charts time is not included. Being that it is time independent, it only shows a date at the bottom of the chart when the price moves up or down at a predefined level i.e. when the chart is set to show a Renko box every time a stock moves more than 1% higher or lower than yesterday s closing price. In the example below, there were no additional Renko bars between the 10 th to the 23 rd of October for this particular stock. But on the 24 th the stock closed higher and therefore recorded a new Renko boxes and the date is now recorded on the chart. Renko charts do not show wicks like candles (high and low of the day), they only concern themselves with price movements in pre-determined increments. I use the charts from close to close i.e. has the price moved up more than 1% from yesterdays close to today s close? If it has a new Renko bar will form. Note that for a green box to change to a red box and vice versa, the stock price in my example will have to move by 2%. The first 1% will move it beyond the last red box and the next 1% to make a green box. Therefore, whatever parameter you are working with in terms of setting up your charts, in order form them to change direction it will have to be a double move. In my example, once it is moving in the same direction (same colour), the Renko boxes will only have to go up 1% to record a new Renko box. Gaps Renko does not display gaps, it simply records the sudden price movement of the underlying by instantly showing the number of Renko bars that are equal to the predefined percentage or point move. I use 1% to show the changes, so if a stock goes up 6% higher at the open due to news coming out about the company 6 green Renko bars will appear. 2

Renko Charts Construction It 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. In our chart below, the bricks that appear in each column all happen within one day. So when you see that some columns are wider than others, this means that the stock moved more than one percentage points up or down verses the last column s days close. The green bricks are used when the direction of the trend is up, while red bricks are used when the trend is down. This type of chart is very effective for traders to identify key support/resistance levels. 3

Disadvantages of Renko Typically a trader using Renko will sell an underlying asset when a red brick is placed at the end of series of climbing green bricks or vice versa after a run of red bricks. Since this type of chart was designed as a way to follow the general price trend of an asset, there can often be false signals where the color of the bricks changes too early, producing a whip-saw effect. As per the area on the chart below:. Additional Parameters There are 4 ways to specify the Brick Size for a Renko chart: Absolute Points, Average True Range (ATR), closing prices or high/low prices. Note that not all chart software packages will allow these four variables. Absolute Points (Futures/Forex Market) With the "Absolute Points" method, you specify the size of each brick on the chart in points. The advantage of this method is that it is very easy to understand and predict when new bricks will appear. The disadvantage is that the point value needs to be different for high priced stocks than for low priced stocks. Typically you will need to choose a value that is roughly 1/20th the average price of the stock during the time frame you want to chart. Common values include 1, 2, 4, and 10. Important Note: The Default for the "Pts" method is currently 14 which is too large for most stocks. You would need to change it to a smaller number to get a useful chart. 4

Average True Range The "Average True Range (ATR)" method uses the value of the ATR indicator to determine the brick size. The ATR indicator is designed to ignore the normal volatility of a stock and thus it can "automatically" find good brick sizes regardless of the value or volatility of the stock selected. ATR with a value of 14 is the default value for Renko charts and should generate a very usable chart in most cases. Close Only This is the method I use. I set up my charts to show daily movements from close to close in increments of 1%. Simply, if the price closes more than 1% higher today than it did yesterday a new green Renko box will form. High/Low Prices Similar to using the closing prices, the High and Lows of the day will determine whether a new Renko box will appear up or down. Conclusion Very few traders use Renko charts. I believe that this is due to the lack of material in literature, particularly in English. Furthermore, the bits and pieces of information on Renko in circulation nowadays make eyebrows rise. The Renko s sheer simplicity invites suspicion. Perhaps this is because we conditioned ourselves for too long into believing that if a theory is not complicated enough, we don t stand a chance of winning! Courtney Smith introduced me to Renko charts and they improved my trading system, therefore they have become a cornerstone in my trading strategy. Millions of dollars have been and will continue to be spent by the financial institutions on the research and development of new and sophisticated trading systems. However, perhaps those financial institutions operate trading systems that are more profitable than the my use of Renko, but as far as the small investor is concerned, in the battlefield where the cents fight the dollars we need all the help we can get and the old Renko wisdom is a sharpened weapon in my battle chest. 5