What is the Ichimoku Cloud Indicator and How to Use it.
The Ichimoku cloud is an efficient technical method that is used in trading analysis to define the future behavior of an asset. In contrast to some other technical indicators, it may seem complex to understand since it includes various data elements. However, experienced trading specialists can analyze the variables that are provided by Ichimoku charts and define the trend direction as well as the price movement of a security. Despite its complexity, the Ichimoku cloud is widely used by the majority of Forex trading platforms as a comprehensive indicator of price momentum, volatility, resistance as well as possible reversals of the value.
In this article, we will provide a complete guide on the Ichimoku cloud indicator that will help traders to expand their knowledge on this key trading tool and empower them to make gainful investment choices.
What Is the Ichimoku Cloud?
Ichimoku cloud, also popular as Ichimoku Kinko Hyo, is a technical analysis method based on Japanese candlestick charting. It was first developed and published by the journalist Goichi Hosoda in 1969. The technique provides a more accurate prediction of an asset’s price moves.
An Ichimoku chart usually consists of five lines that provide useful information about the price performance of an asset. Two of those lines compose a closed area which is known as the Ichimoku cloud. Through this part of the chart, traders can understand if it is an uptrend or a downtrend period. It is a very helpful way to provide new traders with indications about the support and resistance areas of an asset.
The chart above is an example of how an Ichimoku cloud can be explained. When Leading Span A is above Leading Span B and rising, then an uptrend occurs. On the other hand, when A is below B, a downtrend happens. In each situation, the areas between the lines are marked with green or red color respectively. Moreover, when the asset’s price is located above the cloud the overall trend is characterized as bullish and when it is below the cloud it is distinguished as bearish. If the price is placed in the middle of the cloud, it is said that the price is stabilized or fluctuating.
It should be outlined that the price indicator corresponds with the cloud’s movement. The given trend signals’ strength can change depending on if the top of the cloud goes up or down respectively.
The Formula for the Ichimoku Cloud
When calculating the Ichimoku cloud it is very important to take into consideration each period’s highest highs (PH) as well as lowest lows (PL). There is also the mid-point of the highest and lowest prices due to the last nine periods which is called the Conversion line (CL). Here are the five different formulas that are used to count the Ichimoku cloud depending on the given period.
Tenkan Line (Conversion Line): Calculated for the past nine periods
Kijun Line (Base Line): Calculated for the past 26 periods
Chikou Span: Most current closing price (planned for the last 26 periods)
Senkou Span A (Leading Span A): Planned for 26 periods in the future
Senkou Span B: Planned for 6 periods ahead and for the past 52 periods
How to Calculate the Ichimoku Cloud
As it was mentioned above the PH and the PL is the highest and the lowest prices that are detected during a given period. While the technology is being developed, the results of the equations are done by automatic calculations of a computer. However, if a trader wants to dive deeper into the philosophy of how each component of the Ichimoku cloud is being formulated, here are the steps to follow:
- Count the Conversion and the Base Line.
- After knowing the results of the prior calculations, use the known equation to count the Leading Span A. The Senkou Span is planned 26 periods into the future.
- Calculate the Leading Span B. It is measured over 52 past periods and planned for 26 periods into the future.
- Once all the previous calculations are done, define the Lagging Span. This is the closing chart’s price based on a 26-period plan into the past.
- The Ichimoku cloud is created by highlighting the area between Leading Span A and Leading Span B.
- Depending on if the Leading Span A is above or below Leading Span B, the cloud is colored green or red respectively.
- The steps above help to calculate one data point. To draw the lines you need to define new data points following the steps above multiple times. Once the calculations are done, the lines as well as the cloud result from connecting the points.
Base Lines in Ichimoku
Each line of a chart can contain the following :
- A nine (9) period average. This is known as the Tenkan-Sen line.
- A twenty-six (26) period average. This is known as the Kijun-Sen line
- Senkou A Span. The average of Tenkan and Kijun Sen lines.
- A fifty-two (52) period average. It is known as Senkou B Span.
- A twenty-six (26) period average in the past known as Chikou.
Below you can find an extended explanation of each line according to its calculating period.
Kijun-Sen represents the baseline of the Ichimoku indicator and is a moving mid- point. It is calculated in a 26 time period and is based on the high and low of this time. Moreover, it implies the long-term trend of an asset, thus, may not provide precise information about possible price changes.
There are three possible market conditions. indicated by the position of the Kijun line. When the prices and the Tenkan- Sen line are above the Kijun- Sen, we have an uptrend. Otherwise, it is considered to be a downtrend. In some areas, the Kijun line becomes flat. This is an indicator of support and resistance to the price. Moreover, this flatness suggests a sign of market solidarity and entrains the prices.
It is the average of the highest high and the lowest low of the past nine periods. Tenkan- Sen has a fast-changing shape due to alterations in the price. It indicates short-term trends. Moreover, during an uptrend, it supports the price of an asset while due to a downtrend it shows resistance.
Senkou Span A
It is an indicator of future support and the fastest line of the cloud’s boundary. Being an average of Tenken and Kijun Sen lines, It is considered to be of sufficient accuracy. Moreover, Senkou Span A is calculated from the last 26 periods and is considered to be the line of support during an uptrend.
Senkou Span B
It is an indicator of future support and represents the slowest line of the cloud’s boundary. Senkou Span B is the average of the highest high and the lowest low of the last 52 time periods. Last, but not least, it is considered to be the line of resistance during a downtrend.
It is an independent indicator that can move freely in any direction due to an uptrend or downtrend. Chickou Span is the closing price in a 26-period in the past.
The Cloud (KUMO)
The region that is shaded between the lines Senkou A and Senkou B is known as the cloud (KUMO in Japanese. Its thickness indicates how powerful is the support and resistance. KUMO is the key element of Ichimoku that indicates the price trend.
If the overall trend is bearish the price moves below the cloud. Conversely, the price is located over the cloud and the trend is considered bullish. Analysts focus their attention on potential trend reversals that occur when Senkou A suddenly changes place with Senkou B.
Why is Ichimoku Cloud Useful for Traders?
The Ichimoku cloud is a tool that assists traders to identify the potential buy signals as well as foreseeing the future of an asset’s price. Investors often use the KUMO to evaluate the levels of support and resistance that are directly connected to the relative position of the price.
Moreover, traders use the Ichimoku cloud in combination with various technical indicators so that they could optimize their risk-adjusted profits. Very often the KUDO indicator is embodied with RSI (Relative Strength Index) to define the price trends such as momentum, direction, volatility, etc.
Using the Ichimoku cloud, many investors can estimate the performance of an asset by analyzing the points where price intersects with the technical indicator. These points are known as crossovers and are used to monitor the position of the conversion line in comparison with the baseline. When the CL is above the BL traders should realize that this is a potential buy sign. Essentially, analyzing the moves of the lines traders can spot the early momentum signals as well as the point stop-loss and trade exits.
How to Trade with Ichimoku Cloud?
Investors use the Ichimoku cloud as a technical indicator to estimate the price’s action as well as to monitor potential trading signals. Thus, when the price is above the cloud a bullish trend occurs, conversely, when it is below a bearish trend happens. In each case, the Ichimoku level shows a possible buy or sell signal respectively.
Here is a list of conditions that should be fulfilled to certify that the prices are in an uptrend.
- Both Tenkan and Kijun Sen should have a rising trend following the prices.
- While prices need to be above Tenkan Sen, the latter one should be above Kijun Sen.
- The baseline needs to be close to the price.
- The future KUMO trend should be bullish.
- Prices need to be above Ichimoku Cloud.
Furthermore, there are specific Ichimoku criteria that define a downtrend in the price (a bearish trend in the Ichimoku cloud). These criteria are listed below :
- Both Tenkan and Kijun Sen should have a declining trend following the prices.
- Prices need to be under Tenkan Sen and the latter one should be below Kijun Sen.
- The baseline needs to be close to the price.
- The future KUMO trend should be bearish.
- Prices need to be under the Ichimoku cloud.
The Ichimoku Cloud vs. Moving Averages
Both Ichimoku cloud and Moving Averages are technical indicators that keep track of the prices’ trends. They both play a significant role in trading since they provide similar pieces of information in different ways.
The calculations of Ichimoku cloud are based on the average of the highest high and the lowest low over a period. On the other hand, simple moving averages use the closing prices and add them all together. The result of this sum is divided by the total number of prices that are used over a period. Consequently, the results of each method will not be the same, since different values were taken.
Limitations of Ichimoku Cloud
The Ichimoku cloud is considered to be one of the most sufficient yet complicated tools among investors. Its complex nature can make the view of a chart look busy with many data points and lines. Too many components make the Ichimoku cloud indicator very difficult to understand and analyze.
Ichimoku cloud is based on historical data, which makes it less likely that those elements will be repeated. This may lead to some false indications about the asset’s price in the future.
Last but not least, if the price continues to stay for a big period above or below the KUDO, it may lead the cloud to become irrelevant. As a measure of security, the conversion and the baseline, as well as their crossovers, become significant indicators of the price movements.
The Ichimoku Cloud indicator is an efficient technical tool used by many traders. Analysts use the various data points to predict the future price trends and notice possible buy or sell signals. The Japanese candlestick chart may seem complicated but it provides a clear picture of price action. New traders after studying well the terms of Ichimoku cloud can control future risks with stop-loss orders and find ways to exit trades with the highest profit.