The Japanese word “Ichimoku” means “a look”, probably because its creator wanted to generate a technique of technical analysis that, with just a glance, was able to indicate to the trader concrete operational strategies through indicators more complicated to explain than to calculate.
The five indicators used in the Ichimoku technique continually offer points for analysis, mainly operating signals to be placed inside of a trading system.
Supports, resistances, stop losses, entry points, market trend… the technique of the Ichimoku cloud is able to provide all these information through a single glance at the chart.
THE INDICATOR IN DETAILS
A graph consists of 5 lines and, even if its original Japanese name is Ichimoku Kinko Hyo, in the best known version in English it has become Ichimoku Cloud.
Assuming we use a daily chart, the 4 indicators that form the backbone of the technique are:
- Tenkan Sen (Conversion Line) – (top at 9 days + low at 9 days / 2): it shows the average price value during the first temporal range defined as the sum of the top and low divided by 2.
- Kijun Sen (Base Line) – (top at 26 days + low at 26 days /2): it shows the average price during the second temporal range, usually 26 periods.
- Senkou Span A (Leading Span A) – ( Tenkan + Kijun Sen) / 2: it shows the average distance between the two previous lines usually shifted forward by 26 periods. The Senkou Span represents one of the two extremes of the cloud, the so-called anticipating line, thanks to its lower time horizon, and in fact represents the first level of support that an Ichimoku graph is able to provide to the trader in net advance respect the current prices trend.
- Senkou Span B (Leading Span B) – (top at 52 days + low at 52 days / 2): it shows the average price value during the third interval, usually 52 periods, moved forward by the value of the second time range, usually 26 periods. The Senkou Span B is the second extreme of the cloud late in movement with respect to the Senkou A.
Furthermore, to be added to these 4 indicators, we can quote the Chikou Span: it represents the current price moved 26 periods backwards; it may be useful to understand the current trend condition.
As previously mentioned, the price positioning above or below the cloud provides a first important graphic signal on what the market trend is, a key element to define the future direction of the trade.
There are several trading strategies linked to Ichimoku. One of these is represented by the price
behavior around the two Base and Conversion lines.
After determining the direction of the trade that we want to open, depending on the positioning of the cloud, the trader will just have to wait for a price correction below the slower Base line (Kijun); at that point the signal (in this case long), will start when prices will rise above the fastest Conversion line (Tenkan), actually closing the correction.
In order to have a buy signal, three requirements must be met:
- Prices must be positioned above the lower wall of the cloud.
- Prices have to break downward the Base line, materializing a correction that, at the same time, allows a long entry level with an excellent risk-return profile.
- Finally, prices have to rise subsequently above the Conversion Line, effectively formalizing the end of the correction.
Obviously, as we can see from this Google graph, this process takes time and the skill of the trader is to manage the movement with a wise money management aware of the competitive advantage that the Ichimoku technique is offering, sometimes in a repetitive manner.
Clearly, this kind of signal is also generated when we attempt a short operability. Same requirements as the previous long case, but with reversed roles on the Intel action.
- Prices must be positioned below the upper wall of the cloud.
- Prices have to break upward the Base line materializing a correction that, at the same time, allows a short entry level with an excellent risk-return profile.
- Finally, prices have to fall subsequently below the Conversion Line, effectively formalizing the end of the correction.
Let’s now see a practical application, in this case Apple.
The above described technique provides a profitable long or short enter opportunity depending on the dominating trend.
The last part of 2012 and the first half of 2013 showed a clear and dominant bearish trend on Apple as the cloud well describes. There were three “Sell” signals but especially the first one is indicative as it completes the analysis with the information on the exchanged volume.
As we can see from the black vertical line, in that case prices were below the cloud, and after passing the Base line upwards, they have crossed downward the Conversion one; anyway, there is a further information and it is related to the volume, a very high one, reflecting the strength of the bearish signal.
Another graph and another important statement of this technique. The Home Depot action has shown a solid bullish bias throughout 2013, and in three cases the market has offered to the trader the chance to enter long successfully. Also in this case we can highlight the strong signal of February 2013, when volumes exploded at their top during last year.
This last example gives us the opportunity to make a consideration. As all trading techniques attempt to increase the maximum chances of success, but in some cases this does not happen, so it is important to adopt a stop loss strategy to avoid a complete erosion of the capital. The “?” symbol testifies this case. The above described technique provides a bullish signal, but prices come back after a few sessions, bringing a loss to the long trade. In this case the closure below the Conversion line may represent a reliable stop loss.
Obviously, the stop can also be useful to protect the accumulated profits with the Ichimoku cloud entry technique and also in this case we can use several support tools. One of these could be represented by the closure below the Parabolic SAR. After guessing the trend, we could close the trade when the market begins to show uncertainty.
The same Home Depot chart, but together with the Parabolic indicator, shows the strategy to be adopted.
As we have seen, in a single graph based on the Ichimoku cloud, we get the chance to identify trends, corrections, input signals and also stop losses.
Each piece of the graph has a value. The cloud defines the trend and in some cases the stop loss too, but also the Base and Conversion lines, signaling the beginning and end of a correction, and also adequate levels of stop.
Every choice still has to be calibrated in line with other indicators that can confirm the possibility of opening a trade with an adequate risk-return ratio.
The Chikou span is a component of the Ichimoku Kinko Hyo which can be used to pick out bearish and bullish signals. It is given a default green colour on the MT4 chart, and is derived from the close of the current price candle plotted 26 periods backwards. It is a therefore a perfect mirror of price action on a typical trading month.
The key to trading with the Chikou span is to look for its position in relation to the position of the price action, traced back to 26 candles previously. If the Chikou span is above the price action, then this is a bullish signal. If it is found below the price action, then the sentiment in the market is bearish. If the Chikou is found where the candlesticks are, then this is a signal for a market in consolidation.
Once you have been able to identify the position of the Chikou span relative to the price, then the next thing to do is to look for the momentum of the price action. In essence, the trader aims to answer the question on whether the momentum is strong, weak or neutral.
In order to do this, the trader must first bear in mind that the best Chikou span trading signal occurs when the Chikou does not touch the candles. If the Chikou touches any of the candles, then this is a sign of lesser momentum.
As a trader, you want the Chikou to be located far from the price (either to the upside or downside), providing the maximum momentum that the asset has to offer. With this in mind, the trader can proceed to use the Chikou span in the following ways.
As a Support/Resistance Indicator
The Chikou is a trailing indicator and thus can be used to confirm for instance, support and resistance areas. Some commonly used indicators in forex that are used to detect areas of support and resistance are pivot points (for which you need a custom pivot point indicator), the 20ema (dynamic support and resistance) or Fibonacci retracement levels.
If the trader wants to know if a particular area that the price is at is a support or resistance, or neither of the two, all the trader needs to do is to go back 26 periods and study what the Chikou span is doing.
Perhaps the most important use of the Chikou span is in confirming Kumo breaks and TK crosses. Without this confirmation, there would be so many fakeouts that traders would think that using Kumo breaks and Tenkan-Kijun crosses is a bad way of trading the Ichimoku. If only such traders had used the Chikou span for confirmation, they would have avoided plenty of bad trades.
How is this confirmation used?
- For the Kumo break, the Chikou must break the appropriate senkou span line for any price break of the Kumo to be real. Therefore, a bullish Kumo break must be confirmed by a corresponding break of the Senkou span A line by the Chikou span line for us to have real breakout. A bearish Kumo break must also be confirmed by a break of the Senkou span B line to the downside. The chart below shows a true break and a fakeout.
For the fakey example which is clearly seen on the left side of the chart, the price broke through the Kumo to the upside, but the Chikou span (shown as the yellow line for clarity) was still trapped in the cloud. Sure enough, the price remembered that its confirmation partner was not following it up and turned back the way it came (shown as blue and then red arrow).
Now see what happens when the Kumo is broken by the Chikou span and the price action. This was solid confirmation of the bullish movement and we see the price of the asset skyrocketing.
So if you must trade support and resistance or the Kumo break, always use the Chikou span for confirmation.
The Ichimoku Cloud has many strategies build into it, but one of the more popular ones is the Tenkan Kijun Cross strategy. Before we get into the strategy itself, we need to explore the components of it.
The Tenkan line (also referred to as the conversion line or turning line) is a commonly used component of the Ichimoku cloud strategy. This strategy is signaled when the tenkan line crosses over the kijun line. The Kijun line is referred to as the trend line as Kijun-sen means ‘trend line’.
The strength of the Tenkan/kijun cross can be determined on the basis of its position in relation to the cloud or kumo. This strategy and setup is strongest when the bullish cross occurs above the cloud (kumo). The signal is neutral when it occurs within the cloud. It is weak when the signal occurs below the cloud.
Similarly, when the Tenkan line crosses above the kijun line, it becomes a bullish indicator.
Furthermore, when the Tenkan line crosses below the kijun sen, it becomes a bearish signal.
Generally, as we have seen above, the Tenkan/kijun sen cross strategy is categorized into three main parts: strong, neutral and weak. Traders can make trading entries and /or exits depending on the strength of the crossover.
Actually, a long entry requires a bullish Tenkan/kijun crossover to happen above the kumo while short entry requires bearish crossovers to happen below the kumo. Moreover, open positions are exited if a reversal system happens or the close no longer happens below or above the kumo.
Figure 1: Chart illustrating one of the basic classification of the Tenkan/Kijun sen cross
Basically, we have a buy when the Tenkan line crosses above the kijun line and a sell when the tenkan crosses below, however the signal can get a lot more subtle than just that.
Prices above the kumo indicate an uptrend situation while prices below the cloud signify a downtrend situation. The Tenkan/kijun crossovers either above or below the cloud have to be attained since it has short duration and related to kumo support and resistance. The Ichimoku clouds can be used to create a simple Tenkan/Kijun trend-following crossover model.
When the Tenkan/Kijun sen cross has been solidified by a close, then a trader can make an entry order in the direction of the cross. However, the operative Ichimoku practices require the traders to consider any support and/or resistance levels and getting a closing above those levels before attempting an entry order.
An exit order for the Tenkan/Kijun sen cross depends on a variety of signals exhibited by the Ichimoku cloud chart. The Tenkan/Kijun sen cross in the opposite direction of the trade is the most common exit signal. Nevertheless, other factors such as time frame and management risks may dictate an earlier exit or exits due to other signals in the Ichimoku cloud system.
The Tenkan/Kijun line cross strategy allows the trader to execute appropriate time frame and their personal management rules; and then consider the effective structure for setting their stop-loss. This strategy does not dictate any Ichimoku signal for stop-loss placement. It also approaches profit targeting from a day trader perspective and a position trader perspective. From a day trader’s point of view, the take profit targets are set using key levels while a position trader does not set specific targets but prefers waiting for the present trend to be overturned by a Tenkan/Kijun line cross moving in the opposite direction of the trade.
The Ichimoku Cloud, also referred to as a one glance equilibrium chart, increases the probability of trading drastically. How so?
It isolates higher probability trades in the Forex market by excluding more false signals requiring greater confirmation prior to generating a signal.
The Ichimoku Cloud does this by integrating three signals into one chart, enabling traders to make the most informed decisions. The application has been used effectively in the Eastern world especially in Japan for decades before progressing to the Western world. Integrating the Ichimoku cloud and Japanese Candles provided a powerful combination for generating trading signals.
Before trading successfully on the Ichimoku chart, a primary understanding of its components is necessary. Originally, it was constructed by a Tokyo journalist – Goichi Hosoda, with a number of mathematicians running multiple calculations. After three decades of research, Hosada completed the Ichimoku Cloud and brought it out to the Japanese market where it began.
Initially when one looks at an Ichimoku chart, the abundance of the lines drawn may seem confusing. However, the components can be easily identified and translated with just a few simple steps.
The Components of Ichimoku Cloud System
The Ichimoku cloud trading system is essentially made up of five components offering the main insight into Forex trading price action to traders. The five components that we will look into are:
- The Tenkan Sen/conversion line
- The Kijun Sen/base line
- Senkou Span A/leading span 1
- Senkou Span B/leading span 2
- Chikou span/lagging span
The tenkan/conversion line is determined averaging the highest high and lowest low during the previous nine periods, contrary to using the closing prices in most moving averaging systems.
Similarly, the kijun/base line is calculated by averaging the highest high and the lowest low. Despite the calculation being similar, the kijun sen takes the prior 26 periods into account.
The third line which is the Senkou span A also referred to as the leading span 1 forms one of the boundaries of the Ichimoku cloud or what is called the Kumo. The senkou span A/leading span 1 line is determined by calculating the average of the tankan and kijun. It is then projected 26 days into the future.
The fourth line which is the Senkou span B/leading span 2 forms the other boundary of the cloud. The Senkou span B/leading span 2 is determined by calculating the average of the highest high and the lowest low over a period of the previous 52 days. It is then plotted 26 days into the future.
The space between the two leading spans (senkou span A and B), represents the cloud also referred to as Kumo in Japanese. These two spans are projected into the futue to capture the principle of a trend. The projections provide Forex traders with a preview of where the trend support or resistance falls.
The Chikou span/lagging span which is the fifth line, is the current daily closing price projected into the past by 26 days. This lagging span measures the strength of the signals created by the other components.
Figure 1: Ichimoku Cloud Components
Generally, the Ichimoku cloud charts give traders a simple but powerful method to gauge the directional trend of a market. It also provides a powerful tool for identifying key support and resistance levels. Forex traders can anticipate the likely future price trends depending on the location of the cloud. The Ichimoku Cloud is still developing among western traders due to the lack of quality material out there on it. But its high level of accuracy, along with ability to spot future support and resistance levels, along with trending and reversal signals are making this a popular tool for traders looking to gain an edge.