Ichimoku Clouds

Introduction

The Ichimoku cloud is a technical analysis method that was created by Japanese Journalist Goichi Hossada in the late 1960s. The Ichimoku chart shows support and resistance levels as well as other essential information such as trend direction and momentum. It is popularly known as Ichimoku Kinko Hyo. The indicator remains very popular in Japan and there is a theory that it works better when applied to the Japanese Yen currency pairs and the Nikkei as those are the most widely traded instruments.

What Is the Ichimoku Cloud?

Ichimoku cloud is a group of technical indicators which show the support and resistance levels during the intra-day trading sessions. The trading cloud also demonstrates the momentum and trend directions along with the support and resistance levels. The indicator takes various trading averages and plots them on the charts, while also using the figures to calculate a cloud that tries to forecast the point where the script’s price.

The Formulas for the Ichimoku Cloud

The Ichimoku cloud comprises of five lines. Of these two lines comprise a cloud in which the difference between those two lines is shaded in.  The lines in the cloud also comprise of a nine period average 26-period average, 52-period average as well as an average composed of those two averages and finally a lagging closing price line.  Here are the five formulae for the lines composing the Ichimoku cloud indicator.

1. Conversion Line (Tenkan sen) = 9-PH+9-PL/2
2. Base Line (Kijun sen) = 26-PH + 26-PL/2
3. Leading Span A (Senkou span A) = CL + BL/2
4. Leading Span B (Senkou span B) = 52-PH + 52-PL/2
5. Lagging Span (Chikou Span) = Close Plotted 26 periods in the past

In the above formulae

1. PH = Period High
2. PL = Period Low
3. BL = Base Line
4. CL = Conversion Line

How to Calculate the Ichimoku Cloud

The cloud is defined the region between the Leading Span A and B lines, otherwise known as the Senkou A and B lines.  The current support and resistance lines as well as potential future support and resistance lines are identified by the cloud edges. 

When prices changes,  the cloud or komo changed height and shape which in turn affects support and resistance levels.  Large price movements form thicker clouds, creating stronger resistance and support levels while the cloud height signifies to the extent of price volatility. When the clouds are thin, support and resistance levels are viewed as being weak. At times like these it is believed that prices can pierce through those levels more easily.

What Does the Ichimoku Cloud Tell You?

The technical indicator shows relevant information. The overall trend is up when the price is above the cloud. It is down when the price is below the cloud and trendless or transitioning when the price is in the cloud. When Leading Span A is rising and above Leading Span B, this helps to confirm the uptrend and the space between the lines is typically colored green. When Leading Span A is falling and below Leading Span B this helps confirm the downtrend.

Traders use the Ichimoku cloud in conjunction with the other technical indicators to maximize their risk adjusted returns. During every strong downtrend the price may push in to cloud or slightly above it, temporarily before falling again. Only focusing on the indicator would mean missing the bigger picture that the price was under strong longer term selling pressure.

The Difference between the Ichimoku Cloud and Moving Averages

Ichimoku cloud are based on highs and lows over a period and then divided by two.  Simple moving averages take closing prices, add them up and divide that total by how many closing prices there are. In a 10-period moving average, the closing prices for the last 10 periods are added, then divided by 10 to get the average Therefore Ichimoku averages will be different than traditional moving averages, even if the same number of periods are used.

Limitations of Using the Ichimoku Cloud

The indicator can make a chart look busy with all the lines. Most software charting allows certain lines to be hidden.  Each trader needs to focus on which lines provide the most information then consider hiding the rest of all the lines are distracting.  The second limitation is based on historical data. While two of these data points are plotted in the future, there is nothing in the formula that is inherently predictive.  The third limitation is the cloud can become irrelevant for longer period of time as the price remains  way above or way below it.

How this indicator works

The Ichimoku trading strategy can offer alerts for potential buy and sell signals since it is able to identify potential trend.  It is beneficial if you want to define stop loss points which can be at support level. Also the Ichimoku Cloud is used by traders because it provides a certain estimation about the future price level. In general, the Ichimoku Cloud Indicator can be used in your trading strategy for the following:

• Determine Trend Direction

One way to find the trend direction is through the Conversion and Base Lines signals. When the Conversion Line goes above the Base Line, a positive trend is then anticipated. The opposite or negative trend is expected when the Base Line goes above the Conversion Line 

• Support and Resistance Levels

It is identified by the Leading Span A and B Lines, which serve as the edges of the Ichimoku Cloud. Since the Ichimoku Cloud indicator provides price prediction, the cloud edges additionally provide an overview of the current and future support and resistance levels.

• Determine Crossovers

The trader has to  look for crossovers between the Conversion Line and the Base Line. Remember that the trader should pay attention to the location of the crossover so you can determine its strength. Depending on the type of crossover and whether it is located below, inside or above the cloud, the signal can be weak, neutral or strong.

Identifying Trading Signal

The type of signal depends on the element we look at. There are various signals on the Ichimoku chart:

• Conversion/Base Line cross
• Cloud breakout
• Leading Span A and B cross;
• Lagging Span cross

Using this indicator means that you are familiar with the different buy and sell Ichimoku signals, which can appear on your chart as well as other signals. Therefore, the Ichimoku strategy can be created around the Ichimoku signals:

• Bullish trend – the price is above the cloud
• Bearish trend – the price is below the cloud
• Ranging trend – the price is in the cloud
• Buy signal – Conversion Line crosses above the Base Line and both lines along with the price being above the cloud
• Sell signal – appears if the Conversion Line crosses below the Base Line while the price and both lines are found under the cloud.

Conclusion

The Ichimoku cloud technical analysis indicator produces clear buy and sell signals. The trader need to get past some of the lingo, like Tenkan Sen and Kijun Sen. The Ichimoku cloud can be used in any time frame and there is no best time. It completely depends on what type of trader you are. However the trader should be aware of the Ichimoku indicator and it works best when the market is trending and it applies to all time frames.