What is Ichimoku Cloud and how to read it?
Ichimoku Cloud (or Ichimoku Kinko Hyo) is a Japanese technical analysis method. It combines leading indicators, defines resistance and support levels, trends, and provides potential entry points for traders. It is known as a somewhat more advanced technical indicator but one that many professional traders like to use. It provides more data points than standard candlesticks and many traders consider it an improvement over more basic chart setups. The Ichimoku Cloud consists of five lines plotted on a candlestick chart. Being originally a Japanese indicator, many of the original terms have Japanese names, so let’s start with them:
- Tenkan-Sen = Conversion Line, is only the average of the last nine trading periods. To calculate the Tenkan-sen, you would combine the nine-period high with the nine-period low and divide that figure by two. It acts as the centre point of the high-low range over the nine-day period.
- Kijun-sen = Base Line, is the average of the last 26 trading periods. To calculate the Kijun-sen, you would combine the 26-period high and the 26-period low and divide that figure by two. Essentially, the Kijun-sen acts as the mid-range of the 26-day high-low range. This can help you to define whether the asset is trading well above or below its recent average price.
- Senkou Span A (Leading Span A)
- Senkou Span A is the average of the first two lines, Tenkan-Sen and Kijun-Sen. There are 26 time periods between it and the current period, and it forms a faster cloud boundary.
- Senkou Span B (Leading Span B)
- Senkou Span B is the average of a 52-period high and a 52-period low and is also plotted 26 time periods on an forward looking basis, establishing the lower cloud boundary. The Senkou Span B creates a cloud with Span A helping to identify price points of resistance and support. Senkou Span B strictly relies on historical price data, which is used to inform the future potential values 26 time periods into the future.
- Chikou Span
- Chikou Span is just the closing price, plotted along the previous 26 time periods. Experienced traders will look to the Chikou Span to decide whether there is market momentum in an asset – both upwards or downwards.
How to trade with Ichimoku Cloud indicators
By selecting Ichimoku Cloud in your Skilling platform these will automatically be plotted for you. To analyse the indicator:
The Base Line always follows the Conversion Line which is the yellow line in the picture. The Conversion Line is the fastest and most sensitive component of the indicator. The Leading Span A and Leading Span B forms a cloud representing the average of the Base and the Conversion Line. The dark clouds are calculated with 9 and 26 periods, hence they always move faster than the light clouds which are the average of 52 periods.
The theory behind the Ichimoku Cloud indicator is that traders can use a trend that’s based on a moving average to predict whether an asset will move up or down in price next.
If you are wondering how to trade with Ichimoku Cloud indicators for the first time, these clouds are defined by the Senkou Span A and Senkou Span B lines. If you want to know how to read an Ichimoku indicator, the edges of the cloud not only show the latest support and resistance levels but also the likely future support and resistance levels too.
When the price of an asset moves up or down, the Ichimoku Cloud alters height and size, influencing the likely support and resistance levels. Substantial price movements result in thicker Ichimoku Clouds, cementing more reliable support and resistance levels. The height of an Ichimoku Cloud shows an asset’s price volatility. The higher the cloud, the more volatile an asset is to trade.
This indicator is excellent for identifying strong trends and signals for bullish or bearish entries. For analysis, day traders are expected to start with the clouds. The clouds serve to support the entry signals and can therefore indicate the direction of the trend. So, for example, if Span A is above Span B and Chikou Span is above Span B, the market could be considered to be in an uptrend. And it would be classified as trending down provided Span A is below Span B and Chikou Span is below Span A.
So these formations give traders a chance to spot trends, but they can also help to close areas marked when trends change, suggesting potential stop loss levels. Within the Ichimoku Cloud indicator, the price, conversion line and base line can be utilised to pinpoint more frequent trading signals. Whenever the price sits above the cloud – and the cloud is green – this provides a strong, bullish signal to take a long position on the asset in question. When the price sits beneath the cloud – and the cloud is red – this is a weak, bearish signal to open a short position.
The conversion line of an Ichimoku Cloud can also pinpoint when an asset is showing strength in the market. If it crosses beyond the base line, this is a popular indicator to take a long position. Equally, whenever the conversion line crosses beneath the base line, this suggests an asset is weakening in the market. The price and base line can also be used in tandem to find alternative Ichimoku Cloud signals. If the price moves beyond the base line, this also suggests a bullish uptrend for an asset. Equally, if the prices fall through the base line, it also indicates a bearish downtrend.
What is the trigger for entries?
Having identified a trend direction one has to find the best time or price at which to enter the market. The Conversion and the Base Line will provide signals where one might open a short or a long position. Very similar to the 9 and 26 period moving average cross strategy (cross link), one slight difference being that the lines in the Ichimoku indicator are based on the mid prices and not closing prices.
The Ichimoku Cloud should not be the only indicator used for your trading strategies but it does provide a very good indication of potentially sound entry levels. You can easily add this indicator to your Skilling trading platform. You just need to type Ichimoku into the indicator drop down menu. Further, here you can also set up colours as well as change input data.
Ichimoku Cloud is definitely a more advanced technical analysis tool. You should perhaps get familiar with all the Basic and Medium level indicators before you tackle this one. It is used by many professional traders as it provides a deeper level of market insight. As such, we think it is very useful for experienced traders to test and see if they like it but only once they have already attained a certain level in their trading career.
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Not investment advice.