The Ichimoku cloud is a technical analysis method that combines multiple indicators in a single chart. It is used on candlestick charts as a trading tool providing information on potential price support and resistance areas. It is also used as a forecasting tool and many traders use it to try to determine future trends and market dynamics.
The Ichimoku cloud was conceptualized in the late 1930s by a Japanese journalist, Goichi Hosada. However, his innovative business strategy was not published until 1969, after decades of study and technical improvements. Hosada called it Ichimoku Kinko Hyo, which literally translates from Japanese to “chart balance at a glance.”
How it works?
The Ichimoku Cloud system displays data based on leading and latent indicators, the chart consists of five lines:
Conversion line (Tenkan-sen): 9-period moving average.
Baseline (Kijun-sen): 26-period moving average.
Median A (Senkou Span A): Moving average of conversion and base lines projected over 26 periods.
Median B (Senkou Span B): 52-period moving average projected over 26 future periods.
The trail — or latent period — (Chikou Span): the closing price of the current period projected 26 periods in the past.
The space between median A (3) and median B (4) is what produces the cloud (Kumo), which is probably the most notable feature of the Ichimoku system. Both lines are projected out to 26 future periods to provide forecast information and, as such, are considered trend indicators. The Chikou Span (5), on the other hand, is a latent indicator projected over 26 prior periods.
By default, clouds are displayed in green or red for easier reading. A green cloud is created when the range of Median A (green cloud line) is greater than the range of Median B (red cloud line). Naturally, a red cloud results from the opposite situation.
It should be noted that, unlike other methods, the moving averages used in the Ichimoku strategy are not based on candle closing prices. Instead, averages are calculated based on the high and low points recorded during a given period (average of high and low).
For example, the standard equation for a 9 day conversion line is:
Conversion Line = (9d high + 9d low) / 2
Ichimoku Settings
After more than three decades of research and testing, Goichi Hosada concluded that the settings (9, 26, 52) gave the best results. At the time, Japanese business days included Saturdays. The number 9 therefore represents a week and a half (6 + 3 days). The numbers 26 and 52 represent one and two months respectively.
Although these parameters remain preferred in most business contexts, charters are still able to adjust them to suit different strategies. In cryptocurrency markets, for example, many traders adjust Ichimoku settings to reflect the 24/7 markets, often changing from (9, 26, 52) to (10, 30 , 60). Some go even further and adjust the settings to (20, 60, 120) to reduce false signals.
Nonetheless, there is an ongoing debate about the effectiveness of changing settings. Some argue that it makes sense to adjust them, but others argue that abandoning the standard settings would upset the balance of the system and produce many invalid signals.
Analyze the chart
Ichimoku Trading Signals
Due to its multiple elements, the Ichimoku cloud produces different types of signals. We can divide them into momentum and trend signals.
Momentum signals: These are generated based on the relationship between the market price, the baseline and the conversion line. Bullish momentum signals are produced when the conversion line and market price, or both, move above the baseline. Bearish momentum signals are generated when either conversion line and market price slide below the baseline. The crossover between the conversion line (Tenkan-sen) and the baseline (Kijun-sen) is often called the TK crossover.
Trend signals: These are generated based on the color of the cloud and the position of the market price relative to the cloud. As mentioned earlier, the color of the clouds reflects the difference between the A and B medians.
Simply put, when prices are consistently above the clouds, the likelihood of the asset showing an upward trend is higher. On the other hand, prices below the clouds can be interpreted as a bearish sign, indicating a downward trend. With few exceptions, the trend can be considered flat or neutral when prices move sideways in the cloud.
Trail (Chikou Span) is another element that can help traders spot and confirm potential trend reversals. It provides insight into the strength of price action, possibly confirming an uptrend when prices are above market prices, or a downtrend when prices are below. Normally, the drag parameter is used in conjunction with the other components of the Ichimoku cloud and not independently.
In summary:
Momentum Signals
Market price moving above (bullish) or below (bearish) the baseline.
TK Crossover: Conversion line moving above (bullish) or below (bearish) the baseline.
Trend Signals
Market price moving above (bullish) or below (bearish) the cloud.
The color of the clouds changes from red to green (bullish) or from green to red (bearish).
Trailing above (bullish) or below (bearish) market prices.
Support and resistance levels
The Ichimoku chart can also be used to identify areas of support and resistance. Generally, the A median (green cloudy line) serves as a support line during uptrends and a resistance line during downtrends. In both cases, the candlesticks tend to move closer to Median A, but if price is moving within the cloud, Median B can also act as a support/resistance line. Additionally, the fact that the two main zones are projected over 26 future time frames allows traders to anticipate potential areas of support and resistance.
Force you signal
The strength of the signals generated by the Ichimoku cloud strongly depends on whether they match the general trend. A signal that is part of a larger, clearly defined trend will always be stronger than one that appears briefly in opposition to the dominant trend.
In other words, a bullish signal can be misleading if it is not accompanied by an uptrend. So, whenever a signal is generated, it is important to recognize the color and position of the cloud. The volume of transactions must also be taken into account.
Remember that using Ichimoku with shorter time frames (intraday charts) tends to generate a lot of noise and false signals. Generally speaking, longer time frames (daily, weekly, monthly charts) will produce more reliable momentum and trend following signals.
To conclude
Goichi Hosada dedicated over 30 years of his life to creating and perfecting the Ichimoku system, which is now used by millions of traders around the world. As a versatile indicator, Ichimoku clouds are used to identify market trends and momentum. Additionally, medians make it easier for chartists to predict potential support and resistance levels that have yet to be tested.
Although charts may seem overly busy and quite complex at first, they do not rely on subjective human input like other technical analysis methods (e.g. plotting trend lines). And despite the ongoing debate over the configuration of the Ichimoku cloud, the strategy is relatively easy to use.
As with any indicator, however, it should be used in conjunction with other techniques to confirm trends and minimize trading risks. The amount of information this chart displays can also be overwhelming for beginners. For these traders, it is usually a good idea to familiarize yourself with more fundamental indicators before tackling the Ichimoku cloud.