How Renko Charts Filter Market Noise & Improve Trend Analysis

Digging into the deep tool kit of technical analysis, you can find some exotic items for you to use. Just because they are exotic doesn’t mean that they can’t be incorporated into your process. It may even give you that edge because no one else uses them and you are getting a perspective that few see. That’s how I feel about Renko Charts.

Most participants only focus on time. They use the traditional chart types like bar charts and even candlestick charts have become integrated into the norm. Traders and investors often look at 1-minute, 5-minute, or daily candles as if time itself were the only factor of market value or trends. Indeed, standard charting prioritizes time over price. However, by varying your chart type, you can access the instrument from a different perspective. Renko charts in particular operate on an event driven basis. By prioritizing price movement and volatility bands, they provide a different view of market reality, effectively compressing periods of stagnation and expanding periods of high volatility.

By removing time, Renko allows you to see the structural will of the market.

History and Modern Mechanics of Renko Charts

Renko Charts, similar to Candlestick charts, have a Japanese origin. Renko charts go back to the Edo period (1603-1868) in the rice markets. Traders needed a way to track changes in the crop value without getting distracted by the noise of what was happening in the literal markets. Renko comes from renga, the Japanese word for “brick”. Think of Renko as an undulating wall of price, built one block at a time in either green or red.

In the modern platforms, Renko charts function through an event driven horizontal axis. The chart only moves to the right when a price completion event occurs. These bricks are plotted at a 45-degree angle from the previous one, and you’ll never see them placed side-by-side.

The 3 main features of Renko are:

• Brick Size: This is the smallest price move needed to add a new brick. If your size is 10 points, the price must move in the full 10 points for it to show up. So a move of 9.9 points would result in a chart that remains frozen in time.
• Directional Movement: New bricks only come up when the price pushes through the top or bottom of the current brick by the set size. This is set up from a 45-degree angle.
• Reversal Threshold: To post a brick in the opposite direction from where it was going, the price must move twice as much as the brick size from the boundary of the previous brick. This 2x requirement acts as its own low pass filter, ensuring that a minor retracement doesn’t trigger a false reversal signal.

Type of Renko Charts

Not all Renko bricks are built the same. The calculation methodology is determined by your strategic outlook.

The standard ATR setup could be a bit annoying and unstable because it recalculates the entire history based on the current window. However institutions often use ATR Persistence. This is a rolling calculation methodology that ensures the Renko brick structure remains static and does not “repaint” or change its historical shape every time you refresh your data feed.

Construction Methods

The construction of the bricks can vary as well. Some of the construction methods include:

• Closing Price: This only uses the close of a specific timeframe. It is the smoothest method but can ignore intra-period price spikes.
• High-Low Range: This considers the extremes of the period. It reduces lag but reintroduces the noise into the Renko.
• Median/Mean Renko: These establish the open of a new brick at the midpoint of the previous brick. It smoothes even further pullbacks and makes trend reversals easier to identify visually.
• Geometric Renko: This method uses a specific 12.5% extension/inversion to ensure the slope of the bricks stays at a perfect 45 degree angle.
• Turbo Renko: A high filter variant designed to ignore minor pullbacks and only show high probability reversals.

How Traders Use Renko Charts

Indeed, Renko tells you the What but you still need the indicators to confirm the When. This synergy here works very well because Renko acts as a pre-filter for the indicators themselves.

From a Trend Following point of view traders generally use the brick moves to assist in the change of trend. Because of the 2x movement requirement to change brick color, seeing 2 consecutive bricks of a new color confirms that the new momentum has sufficient velocity to likely continue. It helps traders filter out fake out breakouts.

Moreover, peaks and troughs become objective horizontal levels on a Renko chart. These bricks show you where the market’s demand or supply failed to come through, providing clear targets for breakout entries or stop loss placement.

Examples of Technical Analysis Indicator Use

Also, traders include technical analysis indicators with their Renko charts. This combo offers visual clarity, adding a much needed layer of objective validation to its simplified price action. This synergy helps you confirm whether the trend has actual momentum to back it up or if the market is drifting to and fro on low volume.

Moving Averages

Think of using moving averages (MAs) as filtering the filter. A MA on Renko is exceptionally smooth. It would act as support or resistance, helping to determine the ultimate trend direction of the instrument.

RSI

RSI when paired with the Renko measures velocity divergence. If price is printing new bullish bricks but the RSI peaks are trending lower, the energy of the move is dissipating, signaling some level of reversal.

Bollinger Bands

Traders watch for walking the bands. High conviction moves will hug the outer bands. If you see bricks begin to alternate colours while the bands squeeze, you’ve entered a range. This would require some patience as you await a new trend direction to formulate.

35-Pip SPX Renko Chart with SMA and RSI

Technical Analysis Renko Chart of S&P 500 Index

Pros and Cons of Renko Charts

The use of Renko charts basically eliminates the use of time in the chart analysis and focuses on price movements. But this comes with its own challenges.

Bricking It All Together

Renko charts filter the noise in these modern markets. Analysts can ignore the flicker and focus on price moves. But with all types of techniques, it is more useful when combined with other tools. But you would use Renko to find the overarching trend of the market, combining with candlesticks as a secondary monitor to identify exit points and monitor intra-brick volatility.