Ichimoku Cloud is a technical analysis method that consists of several indicators. It is used on a candlestick chart as a tool that provides insight into potential support and resistance zones and is also used to forecast and identify entry and exit points and the future trend.
The Ichimoku cloud was developed in the late 1930s by a Japanese journalist named Goichi Hosoda. However, his innovative trading strategy was not published until 1969, after decades of research and technical improvements. Hosoda called it Ichimoku Kinko Hyo, which means "instant glance at balance" in Japanese.
How does the Ichimoku cloud work?
The Ichimoku cloud system displays data based on leading and lagging indicators. The graph consists of five lines:
Reversal Line (Tenkan-sen): 9 day moving average.
Standard line (Kijun-sen): 26 day moving average.
Senkou Span A: Moving average between the reversal line and the standard line, projecting future 26 day periods.
Senkou Span B: A 52 day moving average that forecasts future 26 day periods.
Chikou Span: The closing price of the current period, which is based on the past 26 day period.
The space between Senkou A (3) and Senkou B (4) is called the cloud (Kumo), which is the most visible element of the Ichimoku system. The two lines forecast future 26 day periods and as such are considered leading indicators, while the Chikou Span (5) is a lagging indicator and provides data based on the past 26 day period.
By default, clouds are highlighted in green and red to make them easier to read. A green cloud is created when Senkou A (the top line of the green cloud) is higher than Senkou B (the bottom line of the red cloud), the red cloud is derived from the opposite interaction of the same lines.
It is worth noting that unlike other methods, the moving averages used in Ichimoku are not based on closed candles. Instead, averages are calculated based on the maximum and minimum values recorded during a certain period (average of the highest and lowest level).
For example, the standard equation for the 9-day reversal line (Tenkan-sen): Reversal line (Tenkan-sen) = (9d high + 9d low) / 2
Settings indicator
After more than three decades of research and testing, Goichi Hosoda concluded that settings 9, 26, 52 produced the best results. At that time, the Japanese work schedule had Saturdays and the number 9 represented one and a half weeks (6 + 3 days), and numbers such as 26 and 52 represent one and two months, respectively.
While these settings are still preferred for most trades, traders can always customize the indicator to suit their strategies and needs. For example, in the cryptocurrency market, many traders adjust the Ichimoku to reflect the 24/7 market, so basic settings like 9, 26, 52 have changed to 10, 30, 60. Some go even further and adjust them to 20, 60 , 120 to reduce the number of false signals.
However, there is ongoing debate about how effective changing the settings is. Some believe that their adjustments make sense, while others argue that abandoning indicator standards upsets the balance of the system and thereby provides many false signals.
Price chart analysis
Possessing many elements, the Ichimoku Cloud generates signals of different types. We can divide them into impulse direction signals and trend following signals.
Momentum Direction Signals: Generated according to the market price and the intersection of the standard line and the reversal line. A bullish impulse signal is generated when one or both lines move above the standard line. A bearish impulse signal is exactly the opposite when one or both lines move below the standard line. The intersection of these two lines in the lower direction is usually called the “dead cross”, and in the upper direction the “golden cross”.
Trend following signals: generated according to the color of the cloud and the position of the market price. As mentioned, the color of the clouds reflects the difference between Senkou span A and B.
When the price is consistently above the cloud, there is a higher probability that the asset is in an uptrend. In turn, if the price moves below it, this can be interpreted as a bearish signal indicating a downward trend. With the exception of some factors, the trend may change to a flat when the price makes a sideways movement inside the cloud.
Chikou Span is another line that can help traders identify and confirm a potential trend reversal. It gives an idea of the strength of price activity and possible confirmation of a bullish trend when moving up or a bearish trend when moving down. Usually Chikou Span is used in conjunction with other Ichimoku Cloud indicators, and not separately as a separate tool.
Support and resistance levels
Ichimoku can also be used to identify support and resistance zones. Typically, Senkou A (green cloud line) acts as a support line during an uptrend and as a resistance line during a downtrend. In both cases, the candles tend to move closer to Senkou A, but if the price moves towards the cloud, Senkou B can act as both a support line and a resistance line. Moreover, the fact that both leading ranges are for future 26 day periods allows traders to anticipate future potential support and resistance zones.
Signal strength
The strength of the signals generated by the Ichimoku Cloud is highly dependent on whether they follow a more widespread trend. A signal that is confirmation of a clearly defined trend will always be stronger than one that arises in opposition to the general sentiment in the market.
In other words, a bullish signal can be misleading if it is not accompanied by a bullish trend. Therefore, whenever a signal is generated, it is important to consider the color of the cloud, its position, and the overall trading volume.
Keep in mind that short-term use of Ichimoku (on intraday charts) tends to generate a lot of noise. Longer time frames (daily, weekly, monthly charts) will generate more reliable signals.
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