4.37 Ichimoku Cloud aka Ichimoku Kinko Hyo

 

Introduction and History

 

Ichimoku cloud was developed during late 1930s by Tokyo newspaper journalist Goichi Hosoda. However, it had taken 30 years of refinements before this technical indicator was released, in the late 1960s, to be used by other traders.

 

Ichimoku cloud, which is called Ichimoku Kinko Hyo in Japanese, is a versatile and very handy technical analysis indicator. It is used to identify entry and exit points, support and resistance levels and the overall trend. What makes Ichimoku cloud different from other indicators is that while it generates trading signals, it also tells us about the strength of those signals. Similarly while it identifies the trends, it also indicates the momentum of the trend. In case of support and resistance levels also, what we get are multiple levels of dynamic supports and resistances. we get to know about all these in just one glance and hence the name Ichimoku, which means “one glance”

 

At the first glance a Ichimoku cloud chart may seem to be a complex set of too many components but the truth is that it that this powerful indicator is quite simple to use.

 

We will try to explain this indicator in a simple manner. However, It would be better if the focus remains on familiarizing oneself with the names of the components and the usage rather than going into the details of the formulas and their construction aspects.

 

Before we start, we wish to mention that the Ichimoku cloud works better on longer time-frame charts (i.e., daily or weekly charts) and should be avoided on shorter time frame charts. In fact we recommend daily charts more than other time-frames.

 

Components and Construction

 

Components of Ichimoku cloud.

 

The above chart illustrates the Ichimoku Kinko Hyo on a Forex trading platform. Please check this chart for a better picture of the construction of this indicator.

 

Components

 

The Ichimoku cloud consists of the following components:

  1. Senkou Span A or Leading Line 1
  2. Senkou Span B or Leading Line 2
  3. Cloud: made by Senkou Span A and Senkou Span B lines.
  4. Tenkan-Sen (Tenkan Line)
  5. Kijun-Sen (Kijun Line)
  6. Chikou Span or Lagging Line

 

Japanese terms related to Ichimoku cloud

 

Being an indicator developed in Japan, all the terms related to Ichimoku cloud have Japanese names. Before we go ahead let's take a look on the meanings of the Japanese terms used for various components.

 

  • Ichimoku: "Ichi" in Japanese means one (1). "Ichimoku" means “One glance”
  • Kinko = Balance
  • Hyo = Chart
  • Ichimoku Kinko Hyo = Balanced (equilibrium) chart at a glance
  • Sen = Line
  • Tenkan Sen = Conversion line
  • Kijun-Sen = Base line
  • Senkou-span A = Leading span 1
  • Senkou-span B = Leading span 2
  • Chikou = Lagging span
  • Kumo = Cloud

 

Calculation

 

The original period setting for Ichimoku cloud, as described later, used to be with periods 9, 26 and 55. Based on these periods the various components of Ichimoku cloud are calculated as follows:

 

  • Tenkan Line = (highest high + lowest low)/2 calculated over last 9 periods.
  • Kijun Line = (highest high + lowest low)/2 calculated over last 26 periods.
  • Chikou Span = most current closing price plotted 26 time periods back.
  • Senkou Span A = (Tenkan Line + Kijun Line)/2 plotted 26 time periods ahead.
  • Senkou Span B = (highest high + lowest low)/2 calculated over past 52 time periods and, sent 26 periods ahead.

 

Lag and Lead times for plotting Senkou and Chikou spans

 

As clear from the above formulas, the Senkou spans which form the main cloud are plotted in advance for the future and the Chikou spans are plotted with a time lag by the same number of periods. These facts are explained visually in the following chart:

 

Ichimoku cloud chart showing the lag and lead time for the calculations.

 

Please note that the above explanation is based on the period settings of 9, 26, and 55. These are the original settings when a trading week used to be a six-day week. Nowadays, many of the traders use the settings of 7, 22, and 44 periods. This is explained in details later.

 

Trading Signals

 

The trading signals generated by Ichimoku cloud are not just limited to entry & exit but also include resistance and support levels and trend identification. Let's take a look on all of these:

 

Resistance and Support Levels

 

Ichimoku provides multiple levels of resistance and support levels. The main resistance and support levels can be derived from the Tenkan Sen, the Kijun Sen, and the upper and lower edges of the main cloud. These levels indicate either the support level or the resistance level depending on the position of the price-action.

 

First level of resistance or support

The first level of resistance or support is Tenkan line. If the price action has been staying above it then this line tends to act as support and in case the price action is below it then you can expect this line to come as the first obstacle or resistance during any upward jump.

 

Second level of resistance or support

The second level of resistance or support is the Kijun Line. When the price-action breaks below the Tenkan Line during an uptrend, then the Kijun Line comes up as the second level of support. Similarly, when the price-action breaks above the Tenkan Line during a downtrend, then the Kijun Line comes up as the second level of resistance.

 

Third and forth levels of resistance or support

The third and fourth levels of resistance or support are either the upper edge or the lower edge of the cloud. When the price-action is above the cloud during an uptrend and both the first and second levels of support of the Tenkan Line and the Kijun Line are broken, then the upper edge and the lower edge of the cloud become the third and fourth levels of support, respectively.

 

Similarly, during a downtrend, when the price-action is below the cloud and breaks above the resistance of the Tenkan Line and the Kijun Line, then the lower edge and the upper edge of the cloud become the third and fourth levels of resistance, respectively.

 

Trend Identification

 

The Ichimoku cloud can be used to identify and analyze underlying trends,  that is, if a trend exists. The trend can be identified as follows:

 

Position of the price-action with respect to the cloud

 

  1. When prices are closing below the cloud, it means a bearish trend.
  2. When the prices are closing over the cloud, it means a bullish trend.

 

Position of the price-action with respect to various support and resistance levels

 

The resistance and support levels are derived from the Tenkan Line, the Kijun Line, the upper edge of the cloud, and the lower edge of the cloud. These levels act as support when the price-action is above these levels, and the same levels become resistance when the price-action is below these levels.

 

Strong Uptrend

A strong uptrend is indicated when the price is above the cloud and continuously stays above the first level of support of the Tenkan Line.

 

Strong downtrend

A strong downtrend is indicated when the price is below the cloud and continuously stays below the first level of resistance of the Tenkan Line.

 

Position of the Chikou Span with respect to the cloud

 

  1. Bearish pressure is indicated if the Chikou Span remains below the current price-action.
  2. Bullishness is indicated if the Chikou Span remains above the current price-action.

 

Bullish and Bearish Crossover Signals

 

The trading signals given by the cloud are of two kinds:

  1. Crossover signals
  2. Non-crossover signals

 

Crossover signals with classification according to strength

 

These signals are generated by the crossover of the Tenkan Line and the Kijun Line. Similar to the strength of the trend, the Ichimoku signals also tell us whether the signal is strong or weak.

 

  1. Tenkan Line crossing over the Kijun Line means a bullish signal for a long-position.
  2. Tenkan Line moving below the Kijun Line means a bearish signal for a short-selling trade.

 

The beauty of this indicator is that it also indicates the strength of the signal so that the weaker signals can be ignored.

 

Points to be observed:

 

  1. Position of crossover with respect to the cloud: The crossover may take place above the cloud, below the cloud or inside the cloud. 
  2. Position of the price-action with respect to the cloud, at the time of the crossover.
  3. Position of the "Chikou span" with respect to the cloud, at the time of the crossover.

 

The logic behind the classification according to the strength is quite simple and is as follows:

  • A bullish signal when the price-action is already in a bullish trend is considered as a strong bullish signal.
  • A bearish signal when the price-action is already in a bearish trend is considered as a strong bearish signal.

 

Strong "Buy" Signals

 

  1. The Tenkan Line moves above the Kijun line.
  2. At the time of the crossover, the price-action is above the cloud.
  3. At the time of the crossover, the Chikou span is above the cloud.
  4. The crossover takes place above the cloud.

 

Medium Strength "Buy" Signals

 

  1. The Tenkan line moves above the Kijun line.
  2. At the time of the crossover, the price-action is above the cloud.
  3. At the time of the crossover, the Chikou span is above the cloud.
  4. The crossover takes place within the cloud.

 

Weak "Buy" Signals

 

If the combination is not as mentioned above, then the signal is to be considered as weak and should be ignored. 

 

  1. The Tenkan line moves above the Kijun Line.
  2. At the time of the crossover, the price-action is NOT above the cloud.
  3. At the time of the crossover, the Chikou span is NOT above the cloud.
  4. The crossover takes place below the cloud.

 

Example of strong bullish signal

 

Example of bullish signal by Ichimoku cloud.

 

Strong Short-Selling Signals

 

  1. The Tenkan Line moves below the Kijun line.
  2. At the time of the crossover, the price-action is below the cloud.
  3. At the time of the crossover, the Chikou span is below the cloud.
  4. The crossover takes place below the cloud.

 

Medium Strength Short-Selling Signals

 

  1. The Tenkan Line moves below the Kijun line.
  2. At the time of the crossover, the price-action is NOT below the cloud.
  3. At the time of the crossover, the Chikou Span is NOT below the cloud.
  4. The crossover takes place within the cloud.

 

Weak Short-Selling Signals

 

If the combination is not as mentioned above, then the signal is to be considered as weak and should be ignored. 

Examples:

  1. The Tenkan Line moves below the Kijun line.
  2. At the time of the crossover, the price-action is NOT below the cloud.
  3. At the time of the crossover, the Chikou span is NOT below the cloud.
  4. The crossover takes place above the cloud.

 

Example of strong bearish signal

 

Example of bearish signal by Ichimoku cloud.

 

Non-crossover signals

 

These signals are generated when during a strong trend there is a consolidation and the price-action hits the support or resistance levels. For example during a strong uptrend if there is a correction and price hits the support level, it would indicate that we may take a long position with the anticipation that the price will get support and will move up again.

 

Ichimoku cloud on top of candlestick charts

 

One major difference with other technical indicators is the limitation of the types of charts on which we apply Ichimoku cloud. All other technical indicators can be applied on various types of charts but for a better interpretation of the price-action and forecasting, Ichimoku cloud is used on the candlestick charts. Application of Ichimoku cloud on a simple line chart only creates visual confusion as Ichimoku cloud itself is made out of 5 lines. Adding one more line to it only creates a visual mess. The other reason is that the complete functionality of the Ichimoku, for correct interpretation the supports and resistances, cannot be used if we use it on a line chart. The reason is simple that a line chart does not differentiate in the important price-moves and the ignorable market noises or temporary spikes. The following two charts explains the above in a visual way.

 

Ichimoku cloud on a line chart

  

Ichimoku signals Vs. candlestick chart signals

 

Let's assume that we get a bearish pattern on a candlestick chart and we take a short-selling position while the Ichimoku cloud is indicating that the current price is near an important support level and no strong bearish crossover signal has been generated by the cloud. In such case it is always better to avoid taking a short position and vice versa as such positions can easily result in losses. Let's have a look on an example indicated in the following Ichimoku chart.

 

Example 1 - Crossover signal contradicting the candlestick pattern

 

Doji and shooting star patterns conflicting with Ichimoku cloud

 

The above example is where Ichimoku cloud signal is contradicting the candlestick chart pattern. There is a doji candle when the price was moving up. This pattern indicates the possibilities of reversal. Immediately after that the next candle was a bearish shooting star candle and that strengthened the bearish signal. However, the price action was near the support of Tenkan line and there was no bearish crossover signal by the Ichimoku cloud. The bearish indications received from the candlestick pattern proved falls as the price found support and continued it's upward journey.

 

On the other hand we can come across a situation where the Ichimoku cloud supports the signals received by the candlestick pattern. Such a situation will make a strong case for going for the trade. The following cloud chart shows such an example.

 

Example 2 - Crossover signal supporting the candlestick pattern

 

Shooting star pattern supported by Ichimoku cloud

 

There was a very strong shooting star bearish pattern immediately after a very strong upward jump. This represented the possibilities of a fall. The same was supported by the cloud as the price had hit the resistance zone of the cloud. These both signals complemented each other and the price fell down by 200 pips.

 

Period settings for Ichimoku cloud

 

The standard period setting for Ichimoku cloud is 9, 26, and 52 periods. This translates into 1.5 weeks, one month, and two months considering a six-day workweek in old days. Many traders tend to change it to 7, 22, and 44, considering the five-day workweek, but the old standard settings of 9, 26, and 52 give good results as many traders still make decisions based on this period setting while trading with Ichimoku cloud.

 

    

       

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