There are different kinds of price charts available to traders. Most are structured to show price movements with reference to time, but some are created to show a specified range of price movements. The Renko chart belongs to the latter. Wondering what the Renko strategy is?
The Renko strategy is a type of charting that is built to show a specified range of price movements rather than time-based price movements like most chart types. It looks like a series of bricks, with each block positioned at a 45-degree angle (up or down) to the prior brick. An up brick is typically colored white or green, while a down brick is typically colored black or red. The chart is best used for trend-following, as it filters out small price movements so that traders can focus on the larger trend.
In this post, we take a look at the Renko charting method and strategy. We would like to make a Renko strategy backtest, but because of the look-ahead bias, you have to be careful. More about that at the end of the article.
What is the Renko chart?
The Renko chart is a type of trading chart that is built to show a specified range of price movements rather than time-based price movements like most chart types. It filters out small price movements so that traders can focus on the larger trend. The chart looks like a series of bricks, with each block positioned at a 45-degree angle (up or down) to the prior brick. An up brick is typically colored white or green, while a down brick is typically colored black or red.
For a brick to be created, the price must move a specified amount in one direction. A brick can be any price size, such as $0.5, $2, $5, and so on. This is called the box size and can also be based on the Average True Range (ATR). If the box size is not reached, a new brick would not be printed. Consecutive bricks do not occur beside each other; thus, when the price changes direction, a new brick is not printed in the new direction until the price moves twice the box size.
Since all movements that are smaller than the box size are filtered out, Renko charts smooth price movements to help traders to more clearly see the trend. When the price is rising, white or green bricks are printed, and when the price is falling, red or black bricks are printed, depending on the colors chosen in the settings.
This makes it easy to spot the current direction in which the price moves and makes trends clearer. When correctly, Renko charts can help to eliminate confusion based on price direction and may improve a trend trading strategy.
Although Renko charts have a time axis, the bricks are not printed based on time intervals. Some bricks may take longer to form than others, depending on how long it takes the price to move the required box size. Renko charts typically use only closing prices of the chart timeframe on which it is set to calculate the price movement. So, if a daily timeframe, then daily closing prices will be used to construct the bricks.
Where does the Renko chart come from? (History)
As with most interesting chart types, such as the candlestick and Kagi charts, the Renko chart has its origin in Japan.
Since the chart looks like a series of bricks, it is thought to be named after the Japanese word “renga”, which is translated as “brick”. The Renko chart is built using price movement rather than price and standardized time intervals like most charts.
How the Renko chart works
A Renko chart consists of bricks representing a specified range of price movement, often known as the box size. The trader determines the brick size for the chart, which then determines when a new brick will form. The bricks are arranged up or down from the previous brick at a 45-degree angle — no two bricks can lie beside each other. So, if the price reverses, it must move double the box size before a new brick is printed in the new direction.
For example, for a market like the S&P 500 e-mini whose price movement is measured in points, if a box size of 20 is chosen, it means that the price needs to move 20 points from the closing price of the preceding brick in order to print a new brick in the current direction. Only moves of 20 points are highlighted by the bricks. Moves smaller than 20 points (from the preceding brick) will not form new bricks.
Also, given that bricks can’t form beside each other, the price needs to move 40 points to form a brick in the opposite direction. Anything less than that would not print a new brick in that direction.
As we stated earlier, Renko charts filter out minor price movements to make it easier for traders to see the important trends. But while this makes trends much easier to spot, some price information, such as the high and low prices, is lost in the bricks.
Usually, Renko charts do not show wicks, but TradingView programmed its Renko chart to use a wick to represent situations of attempted reversals where the price crossed the previous brick but wasn’t big enough to print a new brick in that direction before reversing to continue in the current direction. See the S&P 500 index e-mini chart below:
How to use the Renko chart
If you want to use the rencko chart on a stock chart, the first step is to open the stock chart on your trading platform — TradingView, for example. Then you select the Renko chart from the chart dropdown.
Next, select your preferred box size, which represents the amount of price movement that would print a brick. For example, let’s say you opened the Apple Inc (AAPL) chart, which typically has an average daily range of $4; you can choose a $2 box size. The Renko chart is then plotted on the chart. For every $2 move the price makes in the current direction, a brick is formed. But if the price moves in the opposite direction, it has to make a $4 move for a new brick to be printed in that direction. See the AAPL chart below:
As the price was trending upward initially, when the price moved from $150 to $152 and above, a new green brick was printed. If the price only reached $151.99, a new brick would not have been printed. Once a brick is drawn, it is not deleted. If the price had risen to $154 or higher (and closes there), another green brick would have been drawn for $154. But instead, the price reversed at the $152.32 level. See the comparable candlestick chart below:
Since Renko bricks are not drawn beside each other, the price had to drop by at least $4 for a bearish brick to be printed. That happened when the price dropped to $148 (from $152), and a new pink brick was printed. The price then dropped further to $146, and another pink brick was printed. These bearish bricks are colored pink instead of red because the day has not closed, as our chart is constructed from the daily timeframe. If the day closes like this, the new bearish bricks will be colored red.
Note that increasing or decreasing the box size will affect the “smoothness” of the chart. Decreasing the box size will create more swings, but will also highlight possible price reversals earlier. The larger the box size, the less the number of swings and noise. Also, note that while a fixed box size is common, ATR is also used. ATR is a measure of volatility, so it fluctuates over time. As such, Renko charts based on ATR will use the fluctuating ATR value as the box size.
Which timeframe is best for Renko chart?
The Renko chart is not a time-based chart, so the bricks are not printed based on time intervals. While Renko charts show a time axis, the time intervals are not used in its brick construction. One brick could take months to form, while several bricks may form within a day. It only depends on the amount the price moves and the chosen brick size.
The Renko chart varies from candlestick or bar charts where a new candle/bar forms at specific time intervals. For such a time-based chart, the best timeframe for trading would depend on the result of your backtesting.
Is Renko better than candlesticks and heiken ashi?
- Renko vs. candlestick chart: It depends on your trading strategy — trend following or mean reversion. If your strategy is trend following, Renko charts may be very helpful for you, but if you are a mean-reversion guy, Renko is not your guy. You are better off with candlestick charts. Here’s why: the candlestick chart is based on the timeframe and small price details than Renko charts. A new candlestick will form at every time interval, regardless of how far the price moves and will show the open, high, low, and close prices. Renko charts don’t show the high, low, close, and open of each trading day, and they also don’t form a new brick until a minimum movement threshold is reached or exceeded.
- Renko vs. Heikin Ashi chart: Both Heikin Ashi and Renko charts try to smooth price action to show the trend better. But they differ in the way to do that. Heikin Ashi measures the average of recent price movements, whereas Renko uses a specified price movement threshold to filter out noise. Which one is better depends on the strategy you are trading. Renko would never do well for a mean-reversion strategy but you may manage a Heikin Ashi chart. For a trend-following strategy, Renko may be better.
Renko charts – pros and cons
There are many merits and demerits of using the Renko chart. The merits of using a Renko chart include the following:
- It easily shows the current price direction based on the color of the most recent brick.
- It filters out small price moves, giving you a smoother and cleaner-looking chart.
- It allows you to choose your brick size, which is what determines a price reversal.
- You can use a Renko brick-size calculator to help you determine the optimal brick size or use an ATR-based brick.
- You can identify support and resistance levels easily.
- If you want to trail your trend-following trade, you can use the Renko chart to do that.
Despite its numerous advantages, Renko charts have some demerits. These are some of them:
- Although Renko charts offer cleaner-looking charts, that comes at the expense of some important price details, such as the sessions’ open, high, low, and closing prices.
- While a Renko brick-size calculator may provide an optimal brick size based on past data, the brick size may not be ideal for future price movements.
- When a market is choppy, Renko charts can appear choppy or not print any bar at all, depending on the brick size. In such situations where mean-reversion strategies can make a killing, Renko charts would get you confused.
Renko charts are effective in trading a trend-following strategy since there is a lot less noise than a candlestick chart. Your entry signal could be when the Renko chart shows a change in trend by printing an opposite bar. This is more likely to work out if it happens at a support level. You can identify a support level on a Renko chart if the price continually turns lower or higher near a certain price area.
So, a trade example would be to identify a resistance level and watch the Renko chart print a bearish (green) brick from around that level. If it is a strong trend that forms, you may be able to ride that trend for a long time using the Renko chart. Your exit would be when brick forms in the opposite direction forms. See the chart below:
In this particular trade, you would have ridden S&P 500 e-mini futures down from 4120 to 3721. If you wanted to use a stop loss, you could have placed it one or two bricks away from the upper end of the signal brick.
Renko strategy backtest
Is it possible to backtest a Renko strategy? Yes, but the problem is that Renko charts might enter and exit positions at prices that don’t exist in reality. This leads to curve fitting and completely unrealistic performance.
To give you an example, look at this example from Tradestation:
We tried to make a standard mean reversion strategy, but clearly, the equity curve on the left is completely unrealistic and shows that something is wrong with the backtest (or, the backtest is correct, it’s just that the result is completely unrealistic in real trading).
We made another backtest example in Tradestation:
Again, we can see that the equity curve is too good to be true.
Does this mean that’s impossible to backtest a Renko strategy? No, but you have to be very careful not to make your backtest dependent on the look-ahead bias.
Renko strategy – conclusion
Renko charting is very popular, just like Japanese candlesticks, but most of it is based on anecdotal evidence. Renko might be useful and helpful, but such charting methods are hard to quantify and backtest. As such, use it carefully!