How to Use the Ichimoku Cloud [Strategy Insights & Guidance]
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The Ichimoku Cloud (a.k.a. Ichimoku Kinko Hyo) is one of the most fascinating technical analysis trading indicators traders use for day trading stocks and other financial assets. But how to interpret, read and use Ichimoku Cloud strategies?
The Ichimoku Cloud provide traders support and resistance levels to trade signals that include potential market entry points, over stop-loss order price levels, trend direction and strength indications.
Another interesting fact about the Ichimoku Cloud concerns its origin. It was created by a financial news reporter in Japan rather than by a professional technical or market analyst.
The Ichimoku Cloud has been widely utilized for trading virtually every financial security.
Part of its popularity is because it can successfully be employed across any trading timeframe. Therefore, it’s helpful in all types of investors, running the gamut from scalpers and day traders to long-term buy and hold investors.
This article explains each of the separate Ichimoku Cloud indicators and also shows you the basic trading strategies that can be guided using Cloud signals.
The Ichimoku Cloud Indicator, Part One: Tenkan (Conversion) Line and Kijun (Base) Line
The first two indicators that the Ichimoku Cloud provides are the Tenkan Sen and Kijun Sen lines. These lines are basic indicators of trend direction and trend change. Many traders use these first two components of the Ichimoku system to guide their trade entries and exits.
Like every part of the Cloud, the Tenkan and Kijun lines represent indicators that are simultaneously both simple and complex. The Tenkan Sen is essentially a 9-period moving average, and the Kijun Sen is a 26-period moving average.
However, their calculations are somewhat more complex than those of just a simple or exponential moving average. Fortunately, the Cloud loaded on a price chart does all the calculations for you.
The Tenkan is sometimes referred to as the “conversion line.” but is more frequently termed a signal line. This is because it’s the first line in the Ichimoku system that provides a trend change signal when it crosses over the Kijun line, which is sometimes called the “base line.”
The Ichimoku Cloud, Part Two – the Cloud Explained
The cloud part of the Ichimoku indicator is created with the next two lines in the system, Senkou span A and Senkou span B – sometimes called “leading span A” and “leading span B,” respectively.
Senkou span A is the line marking the top of the Ichimoku Cloud in an uptrend or the bottom of the Cloud in a downtrend. In contrast, Senkou span B marks the opposite end of the Cloud.
As with the Tenkan and Kijun Sen lines, leading span A and leading span B are essentially moving averages of price – but rather complexly calculated moving averages.
The space between the leading span A and leading span B lines is shown on price charts as a shaded area. This shaded area is the actual Ichimoku Cloud, which is used to indicate trend direction and trend momentum.
Most versions of the Ichimoku indicator show the Cloud area shaded in different colors depending on whether Senkou span A is above (a bullish cloud) or below (bearish trend cloud) Senkou span B. In addition, the leading span lines A and B are used as additional indicators of resistance and support, respectively.
The Cloud formation is considered one of the primary advantages of using this technical indicator system. The Cloud shows a general area of price action support and resistance, rather than just the single line price level that most technical indicators use to denote support/resistance.
The Chikou Span Trend Direction and Trend Change Indicator
The most unusual of the Cloud components is the Chikou span. Its line shows the closing price of a security plotted on the price chart 26 time periods back from the current time period.
The Chikou span line indicates current trend direction and/or trend change by its position relative to the Cloud and to the Tenkan and Kijun lines.
Basically, an uptrend is confirmed and considered in place as long as the Chikou span line remains above price and all the other Ichimoku Cloud lines – the Tenkan, the Kijun, and the Cloud itself.
On the other hand, a trend change from uptrend to downtrend is increasingly indicated as the Chikou span makes successive downside crossovers of each Ichimoku line – leading span A, span B, the Tenkan, and the Kijun Sen.
Ichimoku on a Price Chart
The chart below – a one-month candlestick chart of Apple Inc. stock – shows the Ichimoku indicators applied to a price chart.
- The Tenkan Sen is the blue
- The Kijun Sen is the red line
- Senkou span A and B that define the borders of the Cloud are light green and red, respectively. Note that the shaded Cloud area appears green when indicating a bullish trend and red when indicating a bearish trend
- The Chikou span line is olive green – note how, as explained, it trails the current price action by 26 time periods
Crossovers of the Kijun Sen line (red) by the Tenkan Sen line (blue) appear to be pretty reliable trend change indicators. It enables traders to get in on a new trend fairly early and warns them to close out an open trade soon after the market changes direction.
On the right hand side of the chart, you can see where the Chikou span (olive green) line signals a change from downtrend to uptrend a day before the stock price actually bottoms out around the 13th of the month and two days before the Tenkan Sen makes an upside crossover of the Kijun Sen.
It is, thus, serving as a good leading, rather than lagging, indicator. However, it would be best if you exercise caution with the Chikou span. That’s because its early trend change signals may result in your jumping the gun and buying or selling at less than the most favorable price level.
Here’s a shorter timeframe 5-day chart of Apple. Applied to this shorter timeframe, the Tenkan/Kijun crossover signals the change to an uptrend that occurred on the 13th before the Chikou span line does by moving above the Cloud.
On the right side of the chart, note that false signals of change to a downtrend are generated by both the Chikou span line (sharp downward spike) and by the Tenkan and Kijun lines. However, the Cloud itself correctly indicates the uptrend as being still intact.
How to Use Ichimoku Cloud
Here are summations of the main ways that the Ichimoku technical indicator system can be used in determining trade entries and exits.
Basic Tenkan-Kijun Trading Strategy
Buy when price action pushes the Tenkan Sen line to cross from below to above the Kijun line. Sell when the Tenkan conversion line crosses from above to below the Kijun line.
When buying, put an initial stop-loss below either the most recent swing low in price or the most recent low of the Kijun line. When selling short, put your initial stop-loss above the recent swing high or Kijun line high.
Once a trading position is established, the Kijun line can be used as a trend line, indicating support in an uptrend or resistance in a downtrend. In addition, many traders use a trailing stop-loss set just a bit on the opposite side of the Kijun Sen line from the existing trend.
Trading the Cloud
The Cloud itself provides investors with several possible buy/sell trade indications. From the most aggressive to most conservative, they are as follows:
- Buy when leading span A is above leading span B (a bullish trend cloud), and the price has moved from below the Cloud to more than half the distance from span B to span A
- Wait to buy till the price has entirely moved above the Cloud
- Wait to buy till price, and the Tenkan Sen line are both above the Cloud
Initial stop-loss orders with a buy trade are placed below Senkou span B. Short sell orders simply look for the various crossovers to occur to the downside of the Cloud when the Cloud formation is bearish (Senkou A below Senkou B)
Most traders view a market as trendless or ranging when price is within the Cloud.
Chikou Span Trading
The Chikou span line also offers a choice of trading signals. Aggressive traders will initiate long positions whenever the Chikou span is above the price action and above the Cloud. More conservative traders will wait for further confirmation shown by price action moving all of the Cloud indicator lines (except Senkou span B) being above the Cloud.
Trend Strength Notes
Stronger trend momentum is indicated by a wider Cloud area and/or steeper angles of the Tenkan and Kijun lines. Suppose the Cloud area starts becoming more shallow, or the Tenkan and Kijun lines show signs of flattening out. In that case, these are considered early signals of a possible impending trend change.
Some traders supplement the Cloud signals with other technical indicators, such as the RSI or MACD.
Conclusion
Because of its widespread popularity, the Ichimoku Cloud indicator is a technical analysis tool already loaded into most trading platforms and day trading software solutions. Suppose you’re using a trading platform or charting system that doesn’t have it installed. In that case, It’s easy enough to find the Cloud system online and add it to your list of technical indicators. It can also be easily customized to your personal preferences.
The Ichimoku technical indicator system is popular with investors primarily because it provides a clear visual representation of multiple indications of support and resistance, as well as trend direction and trend strength.
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