Ichimoku Cloud is a technical analysis method, which combines multiple indicators in the same chart. This method is used on candlestick charts as a trading tool to help users understand potential support and resistance price zones. It is also used as a forecasting tool, and many traders use this method to identify future trend indications and market momentum.
The Ichimoku Cloud was conceptualized in the late 1930s by a Japanese journalist named Goichi Hosada. However, his innovative trading strategy was only published in 1969, after decades of research and technical improvements. Hosada calls it Ichimoku Kinko Hyo, which translates from Japanese as “equilibrium chart at a glance.”
How does this method work?
The Ichimoku Cloud system displays data based on both leading (trend prediction) and lagging indicators, and the chart is made up of five lines:
Conversion Line (Tenkan-sen): 9-period moving average.
Baseline (Kijun-sen): 26-period moving average.
Leading Span A (Senkou Span A): a moving average of the Conversion and Base Lines projected 26 periods into the future.
Leading Span B (Senkou Span B): a 52-period moving average forecast 26 periods into the future.
Next Period (Chikou Span): the current period's closing price is forecast for the previous 26 periods.
The gap between Guidance Period A (3) and Guidance Period B (4) creates the cloud (Kumo), which is likely the most notable element of the Ichimoku system. These two lines are 26 periods projected into the future to provide predictive information and, therefore, are considered guiding indicators. On the other hand, Chikou Span (5) is an indicator that forecasts 26 periods in the past.
By default, clouds are displayed in green or red - so the results are easier to read. A green cloud is created when Leading Interval A (green cloud line) is higher than Leading Interval B (red cloud line). Naturally, the red cloud is created in the opposite situation.
It is worth noting that - unlike other methods - the moving averages used by the Ichimoku strategy are not based on the closing price of the candlestick chart. Instead, the average is calculated based on the peaks and troughs recorded over a certain period of time (peak-trough average).
For example, the standard equation for the 9-day Conversion Line is:
Conversion Line = (9 day high + 9 day low) / 2
Set up Ichimoku
After more than three decades of research and testing, Goichi Hosada concluded that the (9, 26, 52) setting has the best results. Before that, the work schedule in Japan included Saturdays, so the number 9 represented a week and a half (6 + 3 days). The numbers 26 and 52 represent periods of one and two months, respectively.
While this setup is still preferred in most trading contexts, chartists can always tweak them to suit different strategies. For example, in cryptocurrency markets, many traders adjust the Ichimoku setup to reflect the 24/7 market - often changing from (9, 26, 52) to (10, 30, 60). Some even go further and adjust the settings to (20, 60, 120) as a way to reduce false signals.
However, the effectiveness of modifying these settings remains a matter of debate. While some people believe that it is reasonable to regulate them, some argue that abandoning standard setting will disrupt the balance of the system and create many invalid signals.
Chart analysis
Ichimoku trading signals
Due to its inclusion of many factors, the Ichimoku Cloud generates different types of signals. We can divide them into momentum signals and trend-following signals.
Momentum Signal: generated according to the relationship between market price, Baseline and Conversion Line. Bullish momentum signals are generated when either or both the Conversion Line and the market price move above the Base Line. A bearish momentum signal is generated when either or both the Conversion Line and the market price move below the Base Line. The intersection between the Conversion Line (Tenkan-sen) and the Base Line (Kijun-sen) is often called the TK diagonal.
Trend signals: generated according to the color of the cloud and according to the position of the market price in relation to the cloud. As mentioned, the color of the cloud reflects the difference between Navigation Periods A and B.
Simply put, when the price is consistently above the clouds, there is a high probability that the asset is trending up. Conversely, when the price moves below the clouds it can be interpreted as a sign of falling prices, indicating a downtrend. With some exceptions, the trend can be considered constant or neutral when prices move sideways inside the cloud.
Chikou Span is another factor that can help traders spot and confirm potential trend reversals. It provides insight into the strength of price action, which can confirm an uptrend if it moves above market price, or a downtrend when below market price. Typically, the Later Interval is used in conjunction with other components of the Ichimoku Cloud and not on its own.
Summary:
Momentum signals
Market price moves above (uptrend) or below (downtrend) the Baseline.
TK Diagonal: Conversion line that moves above (uptrend) or below (downtrend) the Baseline.
Trend following signals
The market price moves above (uptrend) or below (downtrend) the cloud.
Cloud color changes from red to blue (uptrend) or from blue to red (downtrend).
Time period After above (uptrend) or below (downtrend) the market price.
Support and resistance levels
Ichimoku charts can also be used to identify support and resistance zones. Typically, Leading Period A (blue cloud line) acts as a support line in uptrends and as a resistance line in downtrends. In both cases, the candles tend to move closer to Leading Period A, but if the price moves into the cloud, Leading Period B can also act as a support/resistance line . Furthermore, the fact that both Leading Periods are predictions of 26 periods into the future allows traders to predict upcoming support and resistance zones.
Signal strength
The strength of the signals generated by the Ichimoku Cloud depends greatly on whether they fit into the broader trend. A signal that is part of a clearly defined larger trend will always be stronger than a signal that only appears temporarily in opposition to the existing trend.
In other words, a bullish signal can be a false signal if it is not accompanied by an uptrend. So whenever a signal is generated, it is important to take into account both the color and position of the cloud. In addition, it is also necessary to consider transaction volume.
Note that using Ichimoku for shorter timeframes (intraday charts) tends to produce many noisy and false signals. In general, longer timeframes (daily, weekly, monthly charts) will produce more reliable momentum and trend-following signals.
Conclude
Goichi Hosada spent more than 30 years creating and perfecting the Ichimoku system, which is currently used by millions of investors worldwide. As a versatile charting method, the Ichimoku Cloud is used to identify both momentum trends and market trends. Additionally, Leading Periods help chartist investment analysts easily predict potential untested support and resistance levels
Although charts may seem confusing and complicated at first glance, they do not rely on subjective human input like other technical analysis methods (e.g. drawing trend lines ). And although there is ongoing debate about Ichimoku's setup, the method is relatively easy to use.
However, as with any indicator, it should be used in conjunction with other techniques to confirm trends and minimize trading risk. Just the amount of information this chart displays can be overwhelming for beginners. For these traders, they should familiarize themselves with the basic indicators before using the Ichimoku Cloud.