Ichimoku Cloud is a technical analysis method that combines multiple indicators in one chart. It is used as a trading tool on candlestick charts to provide traders with reference to potential support and resistance areas. It is also used as a forecasting tool to help traders determine future trends and market momentum.
The concept of the Ichimoku Cloud was first proposed by a Japanese journalist named Goichi Hosada in the late 1930s. However, his innovative trading strategy took decades of research and technical refinement before it was officially launched in 1969. Hosada called it Ichimoku Kinko Hyo, which translates to "balance chart at a glance" in Japanese.
How does it work?
The Ichimoku Cloud system displays data based on high and low price indicators. The chart consists of five groups of parameters:
Conversion Line (Tenkan-sen): 9-day moving average.
Baseline (Kijun-sen): 26-day moving average.
Senkou Span A: The trend is predicted in the next 26 days by the moving average of the conversion line and the baseline.
Senkou Span B: Use the 52-day moving average to predict the trend in the next 26 days.
Chikou Span: The difference between today’s closing price and the midline of the past 26 days.
The space between the Leading Band A (3) and Leading Band B (4) is called the Cloud (Kumo), and this parameter is the most noteworthy element of the Ichimoku system. Both Leading Bands are able to predict the market trend over the past 26 days and are therefore considered leading indicators. On the other hand, the Lagging Band (5) is a lagging indicator that reflects the trend over the past 26 days.
By default, the clouds are displayed in green or red for easier reading. A green cloud is created when Leading Band A (green cloud) is above Leading Band B (red cloud). Similarly, a red cloud is created when the opposite is true.
Unlike other methods, the moving average used by the Ichimoku strategy is not based on the closing prices of the candlestick chart. Instead, the average is calculated based on the highs and lows recorded during a given period (average of the highest high - the lowest low).
For example, the standard calculation formula for the 9-day conversion line is:
Conversion line = (9-day high + 9-day low) / 2
Ichimoku Settings
After more than thirty years of research and testing, Goichi Hosada determined that the (9,26,52) cycle setting worked best. At the time, Japanese business schedules included Saturdays, so 9 represented a week and a half (6 + 3 days). The numbers 26 and 52 represented a month and two months, respectively.
Although the period setting is still the preferred one in most trading environments, chart experts often adjust them according to different situations to adapt to different market trading strategies. For example, in the cryptocurrency market, many traders usually set the Ichimoku period range from (9,26,52) to (10,30,60) to adapt to the 7*24 hour market. You can even set the period directly to (20,60,120) to reduce the generation of false signals.
Nevertheless, there is still debate in the market about how to effectively modify the cycle settings. While some believe that adjusting the cycle makes sense, others claim that abandoning the standard settings will upset the balance of the system and generate a lot of invalid interference signals.
Analyze charts
Ichimoku trading signals
Ichimoku Cloud generates different types of signals as it depends on various elements. We might divide them into momentum and trend-following signals.
Momentum signals: are generated based on the relationship between the market price, the Baseline, and the Conversion Line. A bullish momentum signal is generated when either or both of the Conversion Line and the market price move above the Baseline. A bearish momentum signal is generated when either or both of the Conversion Line and the market price move below the Baseline. A crossover between the Conversion Line (Tenkan-sen) and the Baseline (Kijun-sen) is often referred to as a TK crossover.
Trend-following signals: are generated based on the color of the Cloud and the position of market prices relative to the Cloud. As mentioned above, the color of the Cloud reflects the difference between the Leading Bands A and B.
In short, when the price is consistently above the cloud, there is a higher probability that the asset is in an uptrend. Conversely, when the price moves below the cloud, it is considered a bearish sign, indicating that a downtrend is about to occur. With a few exceptions, when the price moves sideways within the cloud, it is considered a flat or sideways trend.
The Chikou Span is another factor that can help traders spot and confirm potential trend reversals. It provides an indication of the strength of price action, either above the market price for a bullish trend or below the market price for a bearish trend. Typically, the Chikou Span is used in conjunction with other factors of the Ichimoku Cloud and not on its own.
To summarize:
Momentum Signals
The market price is above the Base Line (bullish signal) and below the Base Line (bearish).
TK cross: The Conversion Line moves above the Baseline (bullish) and below the Baseline (bearish).
Trend Following Signals
The market price is above the cloud (bullish) and below the cloud (bearish).
The cloud changes color from red to green (bullish) and from green to red (bearish).
The Lagging Band is above the market price (bullish) and below the market price (bearish).
Support and resistance levels
Ichimoku charts can also be used to identify support and resistance areas. Typically, the Leading Band A (green cloud) acts as support during an uptrend and as resistance during a downtrend. In both cases, the candlestick chart tends to be closer to Leading Band A, but if the price enters the cloud, Leading Band B can also act as support/resistance. More importantly, the two Leading Bands can help traders predict support and resistance areas in the future within a 26-day period.
Signal Strength
The strength of the signals generated by the Ichimoku Cloud depends largely on whether they fit in with the more general trend. A strong signal with a clear trend will always be stronger than a short-lived signal that goes against the prevailing trend.
In other words, a false bullish signal can be generated if it is not accompanied by a bullish trend. Therefore, whenever a signal is generated, it is important to confirm the color and position of the cloud. Of course, volume is also an important factor to consider.
Note that using Ichimoku with shorter timeframes (intraday periods) tends to produce a lot of noise and false signals. Generally speaking, longer timeframes (daily, weekly, monthly charts) will produce more reliable momentum and trend following signals.
Concluding Thoughts
Goichi Hosada has been creating and perfecting the Ichimoku system for over 30 years, and it is now used by millions of traders around the world. As a versatile charting method, Ichimoku Clouds are used to identify market trends and momentum. In addition, the leading band can help experts predict potential support and resistance levels more easily.
Although Ichimoku charts can seem very complex and difficult to understand at first, they do not rely on subjective human input like other technical analysis methods (e.g., drawing trend lines). Despite the ongoing debate about Ichimoku settings, the strategy remains relatively easy to use.
Like any other indicator, the Ichimoku should be used in conjunction with other techniques to confirm trends and minimize trading risk. For beginners, the sheer amount of information displayed by this chart can also be overwhelming. For these traders, it is often helpful to consider other, more basic indicators as well before tackling the Ichimoku Cloud.