Ichimoku is a unique trading tool for analysing any asset in any timeframe. To the outside observer, at first glance it looks a complete mess. Untangle it though and you have a straightforward and very powerful all round trading system that can seriously boost your trading results. This blog presents a simple overview of this system, building up the tools of Ichimoku using the S&P 500 Stock Indices as the base example, hopefully giving the reader an initial starting point on their journey into a unique part of Technical Analysis.
Ichimoku, otherwise known as Ichimoku Kinko Hyu, was developed by a Japanese journalist Goichi Hosoda and published in his book in 1969. It means ‘one look’. It is a collection of technical analytical techniques to determine:
- The trend
- Support and resistance
- Trading signals
- Entry and exit points
The basic components of Ichimoku:
It is made up of 5 key parts. 4 of the 5 are based on the average high / low over a given period.
- Tenkan-sen (Conversion Line): (9-period high + 9-period low)/2))
- Kijun-sen (Base Line): (26-period high + 26-period low)/2))
- Senkou Span A (Leading Span A): (Conversion Line + Base Line)/2))
- Senkou Span B (Leading Span B): (52-period high + 52-period low)/2))
- Chikou Span (Lagging Span): Close plotted 26 days in the past
The inputs above are the original default settings. However, there is nothing to stop you changing and adapting a different set up.
Ichimoku rules: The cloud
Senkou Span A and B form the shaded area known as the cloud, or to give its official name, the Kumo. The cloud changes trend direction when these two lines cross. In the example here for clarity, Blue signifies bullishness and Yellow Bearishness. You’ll probably find standard defaults in most chart packages to be: a red cloud signifies bearishness and a green cloud bullishness. Again, there are no rules to say what colours you need to use. The cloud can offer good support and resistance levels.
There are two ways to identify the overall trend using the Cloud.
1. The trend is up when prices are above the Cloud, down when prices are below the Cloud and flat when prices are in the Cloud.
2. The uptrend is stronger when the Leading Span A line is rising and above the Leading Span B line. This situation produces a Blue Cloud. Conversely, a downtrend is stronger when the Leading Span A line is falling and below the Leading Span B line. This situation produces a Yellow Cloud.
The Cloud is also shifted forward 26 days, so as to provide a view on future support or resistance.
Ichimoku rules: The Conversion Line and the Base Line
These are used to identify faster, and more frequent, signals. They are very similar to the Western moving average crossover system. Trading signals occur when the two cross:
- Conversion line > Base line = Bullish
- Conversion line < Base line = Bearish
Remember: bullish signals are reinforced /preferred when prices are above the cloud and the cloud is Blue.
Bearish signals are reinforced / preferred when prices are below the cloud and the cloud is Yellow.
Ichimoku rules: The Chikou Span
This can be used to pick out bearish and bullish signals. It is therefore perceived as a mirror of price action in a typical trading period. To use it, you must look for its position in relation to the position of the price action, traced back to 26 candles previously.
- If the Chikou span is above the price action, then this is a bullish signal.
- If it is found below the price action, then the sentiment in the market is bearish.
- If the Chikou is found where the candlesticks are, then this is a signal for a market in consolidation.
Its primary uses are for confirming support and resistance and pin pointing breakouts through the cloud.
Taking it further:
Why not add a Western indicator or even other Japanese methods, to give further transparency around timing, entry and exit to build an even more robust trading strategy. In the example below, a stochastic indicator has been added to a Heikin Ashi S&P500 Daily Ichimoku set up:
Once the components to this system are understood, then it becomes quite apparent that this is indeed a very useful trading tool. Your options are endless with Ichimoku and this is what makes this a fascinating and exciting Technical Analysis tool. Enjoy!
Article by Stephen Hoad BA Hons, MSc, MSTA
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