- 1 What is The Ichimoku Cloud?
- 2 How Does Ichimoku Cloud Work?
- 3 What is the Best Time Frame For Ichimoku?
- 4 How Do I Use Ichimoku Cloud For Day Trading?
- 5 Is The Ichimoku Cloud Trading Strategy Good?
Ichimoku Cloud is a versatile technical analysis indicator rapidly rising in popularity among traders. Also known as Ichimoku Kinko Hyo which translates to ‘one look equilibrium chart’ – this is exactly what Ichimoku strives to be. An ‘all-in-one’ style indicator that incorporates multiple elements from different technical analysis tools. At just a glance traders are able to ascertain future support and resistance, price momentum, and trend direction.
While the abundance of lines and shaded areas can leave traders new to the Ichimoku cloud indicator confused and even a little intimidated. Once you single out and understand each separate element, mastering Ichimoku Cloud is easier than it looks. We take you through each component of the Ichimoku Cloud indicator and the strategies you can use to improve your trading.
What is The Ichimoku Cloud?
The Ichimoku Cloud indicator essentially combines three indicators into a single chart so traders have multiple tests on price action. It can be used to analyze any tradeable asset, from stocks, options, futures, etc. A key component of the indicator is the ‘cloud’ that acts as support and resistance. There are also five lines that represent different time intervals. These elements allow traders to decipher the strength of trend direction and gauge momentum. This in turn can signal trading opportunities and optimal entry/exit points.
There’s also an interesting origin story. Unlike most technical indicators that are formulated by statisticians and mathematicians, the Ichimoku Cloud indicator was developed by a Japanese journalist Goichi Hosoda. By analyzing the centuries-old Japanese rice markets, Hosoda came to the conclusion that markets are ‘human’. They are social creatures in that they are both the product of and have an influence on human behavior. Like people, markets can swing wildly but it is unusual to stay at extremes. There is always a return to equilibrium. After decades of endless computations and revisions, Hosoda and his team concluded that what is now known as the Ichimoku Cloud, was the best chart representation of market reality. Hosoda publicly shared the technique in 1968. The indicator is now heavily used by many Japanese trading rooms and rapidly growing in popularity worldwide.
How Does Ichimoku Cloud Work?
If you’ve never looked at an Ichimoku Cloud chart before, you’d be forgiven for thinking ‘what a mess’. The abundance of squiggly lines can create a cluttered and chaotic chart that can leave traders feeling overwhelmed. However, for those that subsist and take the time to learn Ichimoku Cloud, understanding the indicator is simpler than it looks. But to fully comprehend the indicator, we need to break it down into the individual components that make up the Ichimoku Cloud and build it back up.
The Components of Ichimoku Cloud
The Conversion Line – The short-term line that is the most responsive to price action. Represents the average of the high and low divided by two for the previous nine time periods.
The Base Line – The long-term line that is less responsive to price action. Represents the average of the high and low divided by two for the last 26 periods.
While the Tenkan Sen and Kijun Sen lines may look eerily similar to your traditional moving averages, there is one big distinction. They use the highest high and the lowest low over the time period instead of the closing price which is used in most moving average calculations. By taking the average of the price extremes and dividing by two, Tenkan Sen and Kijun Sen result in a line that more closely resembles support and resistance. While the difference in the calculation may be subtle, the result is widely different even if the same number of periods are used.
Lagging Span – Represents the closing price for the previous 26 periods. Traders can easily visualize market sentiment and the intensity of trend direction by comparing current price movements with that of the previous movements.
Leading Span A – The future indicator for 26 periods. It is calculated by taking the middle of Tenkan Sen and Kinjun Sen for the previous 26 periods and plotting the values 26 periods ahead of the current price action.
Leading Span B – The second future or leading indicator. It is calculated by taking the average of the highest high and lowest low of the previous 52 time periods and the values plotted 26 periods ahead of the current price action.
The Ichimoku Cloud – Is the shaded area between the Senkou A (Leading Span A) and Senkou B (Leading Span B) lines. It represents current and historical price action and its color will change depending on the movements of the Senkou A and Senkou B lines. When Senkou A (Leading Span A) crosses above Senkou B (Leading Span B), this signals an upward trend and the Kumo will be colored green (there may be a slight variation in color depending on your trading platform). Where Senkou Span A falls below Senkou Span B, this signals a downward trend and Kumo will typically be colored red.
What is the Best Time Frame For Ichimoku?
Ichimoku Cloud can be used in any market and in any timeframe. What is the best timeframe largely depends on your trading style. Scalpers and day traders may benefit from using shorter time periods from anywhere form one min charts to six-hour charts. Although it doesn’t hurt to zoom out to larger time frames to understand the bigger market picture. Longer-term swing traders or investors are better suited to looking at daily or weekly charts. As with all trading strategies, your trades will still need to be managed, so pick a time frame that you can reasonably monitor and follow.
How Do I Use Ichimoku Cloud For Day Trading?
A simple way to see the trend is to look at the color of the cloud. When the cloud is shaded green, this confirms a positive trend. When the cloud is shaded red, this confirms a negative trend. You can also factor in the size of the cloud to determine the strength of the trend. Where the cloud between Senkou A (Leading Span A) and Senkou B (Leading Span B) is small, this signifies that the trend is weak. A large cloud can be interpreted as a strong trend.
Another way to use the Ichimoku Cloud is to look at the current price action. Where the current price is above the cloud, this further supports the strength of the bullish trend. Below the cloud, a bearish trend. And when the current price is located within the cloud, the market is consolidating and range bound.
Furthermore, where the five lines are running parallel to each other, it is safe to assume that the market will continue in that direction.
Support and Resistance Levels
The upper band of the prevailing cloud can act as an area of resistance while the lower band acts as a support level. Where the current price breaks above the cloud this is akin to a breakout and below the cloud for a breakdown. This signifies a deep shift in market sentiment and the regular rules of supply and demand are in play.
The Tenkan Sen and Kijun Sen lines can be used in a similar fashion to moving average crossovers. When Tenkan Sen crosses above Kijun Sen, this is considered a bullish trading signal. When Tenkan crosses below Kijun Sen, this is considered a bearish trading signal. Many traders will enter and exit trades based on these crossover trading signals.
Where Chikou Span is above the current price, this is an indication that there is strength in the price and it is expected to move higher. When Chikou Span is below the current price action, this an indication of weakness in the price. Traders can look for instances where Chikou Span crosses with price as a sign of a trend reversal. Where Chikou Span crosses above price, this signals that an upward trend has started and that the price is increasing. Where Chikou Span crosses below price, this signals a downward trend and that price is falling.
Putting It All Together
Buy and sell signals are even stronger when you consider each component of Ichimoku Cloud and make sure they are used in conjunction with each other.
Where price action is trading above the cloud and this is coupled with a bullish crossover of Tenkan Sen and Kijun Sen, this indicates powerful buy signals. The probability of the trade is even further increased where Chikou Span is above price action. Many traders will hold this position until Tenkan Sen crosses back below Kijun Sen which indicates a strong sell signal.
Is The Ichimoku Cloud Trading Strategy Good?
The greatest strength of Ichimoku Cloud is that in just one glance, a trader can interpret a wealth of information. But don’t forget that all indicators have weaknesses. The best way to combat these weaknesses is to understand, expect, and plan for them. We go through Ichimoku Cloud’s limitations below.
While Ichimoku Cloud provides future leading lines these data points are calculated using historical data and are just projected into the future. There is nothing inherently predictive in the formula. It is still a lagging indicator. It is still playing catch-up to current price action. Where there are quick market reversals, the indicator may give off late signals. As always, backup Ichimoku Cloud signals with your own price action analysis.
Ichimoku Cloud is in its prime element in trending markets. However, when the markets are range bound and no clear trend exists, Ichimoku Cloud has a tendency to give off false signals. As explained above, it’s still a lagging indicator so it may be slow to react to quick market reversals. As always, be cautious. Don’t just jump into a trade unplanned. Wait for the price correction. Test support and resistance levels and then enter a trade once there is a confirmation of the trend. Even though you may miss out on the start of the trend, you will be less susceptible to false signals.
Ichimoku Cloud works best for the visual traders. However, it is easy to get lost and feel overwhelmed by all lines and chaos. One thing we preach is to maintain clarity in your analysis, so one way to combat the ‘busyness’ of the chart is to focus on a set of lines at a time. Until of course, you become comfortable enough to glance at them and clearly understand their meaning. Most if not all charting software will allow traders to hide certain lines. If you’re looking specifically at the cloud and you find that the Tenkan Sen and Kijun Sen lines are distracting, get rid of them. Only include elements that are going to influence your trading decisions.
Where Ichimoku Cloud was once relegated to the list of ‘exotic indicators’, traders are now turning to Ichimoku Cloud as a sophisticated and effective way of evaluating the markets. But be mindful not to get too carried away. While Ichimoku Cloud can be a fantastic asset, no technical analysis indicator should be used on its own. As always, there is no replacement for watching price action and the key areas of support and resistance.
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