The Ichimoku cloud is also known as the Ichimoku Kinko Hyo. The Ichimoku is an indicator used in technical analysis in the forex market, futures market, stocks, commodities, indices, and more. It was published by Goichi Hosoda in 1969 after 30 years of research.
This was a spectacular discovery in that, unlike most other indicators that were developed by traders or people who had some form of market experience, Hosoda was a journalist. When applied to the charts, it may initially appear confusing to a newbie trader, but once the trader is able to understand what the Ichimoku is used for, it can be a high probability system for trading the markets.
The Ichimoku cloud is used in technical analysis and trading in several ways. Some of these are as follows:
- As a determinant of the trend
- Identification of key support and resistance levels or event areas
- A gauge of momentum
Generally speaking, the Ichimoku cloud can give the trader volatility signals, as well as signals for trade entry and trade exit by showing exactly where a stop loss or take profit target point could be placed.
Simply put, the Ichimoku is a complete, standalone indicator that can be used to achieve all trade objectives, even without combining it with any other indicator in the market.
Components of the Ichimoku Kinko Hyo
The Ichimoku indicator is made up of the following components:
a) The cloud (kumo)
b) Tenkan sen
c) Kijun sen
d) Senkou Span A
e) Senkou Span B
f) Chikou Span
The kumo is the cloud, which corresponds to the white shaded area on the chart. The relationship between the price action (video resource here) and the kumo in terms of position determines the trend of the asset.
The Senkou Spans
Two lines bordering the cloud: the Senkou Span A (the brown dotted line) and the Senkou span B (the white dotted line). The Senkou span A is usually above the Senkou span B in an uptrend, while the reverse is the case in a downtrend. So whenever there is a trend reversal, the cloud (kumo) eventually twists on its axis so that these lines reverse their positions. The Senkou Spans A and B are the leading lines.
Senkou Span A is made up of the Tenkan and Kijun lines, plotted 26 periods ahead. Senkou Span B is the highest high and lowest low that is calculated 52 periods and set 26 periods ahead.
The Tenkan sen (Tenkan line) is the red line shown in the chart, while the Kijun sen is the blue line shown on the chart. These two lines occasionally cross each other to form a TK cross, which is a trend reversal signal. The Tenkan line is the support-resistance line and is the signal trigger line. The Kijun line also functions as a support-resistance line. In other words, when the Tenkan is functioning as a resistance, the Kijun sen functions as the support. In this scenario, the Kijun can be used as a stop loss while the Tenkan functions as the profit target.
The Chikou span is a filter, and is plotted 26 periods back, providing information of current price in relation to the price of the asset 26 periods away. How does it serve as a filter for trades? If the Chikou span is found above the price action, this gives a bullish signal. If the Chikou span is found below the price action, this gives a bearish signal. If the Chikou span is found within the price action, this is a signal of price consolidation.
Putting it All Together
The Tenkan and Kijun sen as well as the Senkou span A and span B lines all can be used as support and resistance points. A price that has broken downwards below the Tenkan and Kijun lines will turn them into first and second resistance points, and then turn the Senkou lines bordering the kumo (cloud) into first and second support lines. The size of the cloud determines the potential for a kumo break. The larger the cloud, the least likely it is that the kumo can be broken.
In summary, there are three ways of using the Ichimoku Kinko Hyo:
- The TK cross, which serves as a reversal signal. If the Tenkan sen crosses the Kijun sen upwards so that the Tenkan sen is above the Kijun sen, this is a bullish reversal signal. The reverse would be a bearish reversal signal.
- Support and resistance trades using the Tenkan, Kijun, Senkou span A and Senkou span B lines, just like pivot points are used for support and resistance trading.
- Bounces and breaks of each of these lines or the kumo.
In all these, the trader should always use the Chikou span as a filter.