Noise removal is a vital aspect of active trading: traders need to avoid interpreting false signals, and have a clear picture of overall trends. In this blog, we'll look at what's considered noise in stock trading, and how ComponentOne Studio's FinancialChart control can help developers eliminate noise in financial applications.
What is Financial Noise?
In stock terminology, noise refers to random or short-term market fluctuations that distort the picture of underlying trends, making it difficult to forecast the market's direction. They can be confusing and misrepresent genuine underlying trends, and cause investors to react by buying or selling the stock. However, if the noise continues in a certain direction, it becomes a trend, which is a more objective assessment of the stock's value.
With Heikin-Ashi and Renko charts available in FinancialChart control (available in WinForms, WPF, UWP, ASP.NET MVC and Wijmo), the developers will be able to simplify their users' decision-making process by minimizing the effect of stock market noise, filtering out small corrections, and bringing profit.
Let's first understand the effects of stock market noise in one of the simplest financial chart available with FlexChart/FinancialChart: Candlestick chart. Thereafter, using the same data, we'll visualize how Heikin-Ashi and Renko charts can be utilized to filter stock market noise and predict future trends. Both these charts will help stock trader to take correct decision at the right time, thereby increasing their trading profitability.
In a conventional Candlestick chart (available in FlexChart/FinancialChart), data is visualized through Open, Close, High and Low stock prices for the specified duration in the series.
Candlestick charts are easy to understand and useful in predicting market trends. This helps user to decide when to buy, sell or wait on a trade or investment. Through FlexChart, candle lines can be drawn using any specified time-frame along with visualizing several patterns (Reverse, Doji, Hammer, Hanging Man, etc.), which, in combination with other technical indicators, provide reliable technical analysis for decision-making.
Since Candlestick charts are time-based charts, they look different and give different results whenever the time-period is changed. Moreover, if the specified time-period range is small then these charts look cluttered and show a lot of noise (Fig 1.3) which can easily distract user in taking a correct decision.
In candlestick charts, decision-making is a bit complicated, since the individual candle has no relationship with previous and next candle. Heikin-Ashi chart resolves this problem by using the previous candle data as a base for generating the current candle.
Heikin-Ashi chart uses the open-close data from the prior period and the open-high-low-close data from the current period to create a combo candlestick. The resulting candlestick filters out some noise in an effort to better capture the trend. These candlesticks help to improve the isolation of trends to predict future prices more reliably than Candlestick charts.
Calculation of Heikin-Ashi chart
The method of calculation and candle-plotting on ComponentOne Heikin-Ashi chart is different from the candlestick chart:
- Open price: the open price in a Heikin-Ashi candle is the average of the open and close of the previous candle.
- Close price: the close price in a Heikin-Ashi candle is the average of open, close, high and low prices
- High price: the high price in a Heikin-Ashi candle is chosen from one of the high, open and close price of which has the highest value.
- Low price: the low price in a Heikin-Ashi candle is chosen from one of the low, open and close price of which has the lowest value.
Heikin-Ashi vs. Candlestick Chart
Since Heikin-Ashi chart uses the price of the previous candle as a base for the current candle, it's slower than the candlestick chart, and its signals are delayed. This delay is one of the major advantages of Heikin-Ashi chart, as it prevents the user from erroneously trading against the market trends. Let’s look at an example:
Identify Trends in Heikin-Ashi chart for Opportunities:
|Hollow Candles with no lower shadows||Strong Uptrend||Depicted as green numbers in the above chart. Corresponding values in Candlestick chart are showing a downtrend|
|One candle with small body surrounded by upper and lower shadow||Trend Change||Depicted as blue arrow in the above chart.|
|Filled Candles||Downtrend||Depicted as red arrow in the above chart. Corresponding values in Candlestick chart are showing a trend change|
|Filled candles with no higher shadows||Strong Downtrend||Depicted as red number in the above chart. Candlestick chart is showing a Trend change.|
As we compare the above two charts in detail, we find that when Heikin-Ashi chart is showing a strong downtrend, while the candlestick chart is just showing a trend change. Moreover, when Heikin-Ashi chart is showing a strong uptrend, Candlestick chart is making a short-term noise through a downtrend.
Even though Candlestick and Heikin-Ashi charts help users in making good decisions, they're still time-based charts. Time is often considered to distort price movements, and this belief gave birth to Renko charts which focus only on price movement.
The word “Renko” is derived from the Japanese word “Renga” – which means “brick." Compared with conventional candlestick and Heikin-Ashi charts which print a new candlestick in user-selected intervals, Renko charts only focus on price itself. Renko charts eliminate noise and are much cleaner charts than regular price action charts, as less information will be presented for users to act upon.
Along with filtering noisy market scenarios, Renko charts are more efficient in technical analysis by establishing an objective-oriented approach for helping users. Swing highs and lows are easy to spot, and breakouts are visible immediately.
As you can see in the above snapshot, Renko charts use price “bricks” that represent a fixed price move to filter out smaller price movements. These bricks move up or down in 45-degree lines with one brick per vertical column. Bricks for upward price movements are hollow (white in color) while bricks for downward price movements are filled with a solid color (typically black or blue).
For a new white or black brick to be drawn in a Renko chart, the stock value must increase or decrease by user-defined brick or box size value. Price advancement less than brick or box size value will be ignored, and the Renko chart will remain unchanged.
An important aspect of the Renko chart is that the white and black bricks are rendered in equal size. Thus, no matter how large the move, the short-term noise is filtered by displaying equally-sized bricks.
Three characteristics of Renko chart
This is the size by which the stock must advance for a new white brick to be drawn. If the Box size is set to 1, and the stock advances by 2 points, then two bricks (boxes) of white color will be drawn in Renko Chart.
Fixed Value versus Average True Range
Renko chart provides a Range Mode setting to set brick size as:
- Fixed value - Brick size will remain constant even if new data is incorporated into the Chart.
- Average True Range (ATR) - Brick size changes when the ATR value is used. The brick size is based on the ATR value at the time the chart is created. Should the ATR value change the next day, then this new ATR value will be used to set the brick size.
Close versus High-Low Range
Renko charts can be based on closing prices or on the high-low range by using the “DataFields” setting. Closing price means that there is one data point per period and less volatility. The high-low range puts two data points into play and increases the fluctuations, which results in added bricks. Besides these, there are 5 more options for DataField setting: