We’ve had a few questions recently about the Ichimoku cloud or Ichimoku Kinko Hyo as it’s otherwise known, so in this article, we are going to take a look at this indicator and explore its uses as a trading tool. The indicator is an incredibly popular tool in Forex trading and is certainly worth exploring if you are a fan of indicator trading.
Ichimoku Kinko Hyo
The term Ichimoku Kinko Hyo translates into “one look equilibrium chart” and the premise behind the indicator, which was developed by Goichi Hosoda in the 60s, is that traders can identify the direction of the trend as well as signals for entry, all based on one indicator.
Understanding The Indicator
The indicator itself features four main parts:
- The Tenkan Sen line (conversion line) which is in red and set to a default 9 period.
- The Kijun sen line (baseline) in the blue set to a default 26 period.
- The Chikou span line (lagging span) in lime set to a default 52 period.
- The cloud which is shown in both orange and pink.
Identifying Trend With Ichimoku
Essentially, there are two methods for identifying trend direction using the cloud. Firstly – the trend is classed as bullish when the price is above the cloud and bearish when the price is below the cloud, and secondly, the trend is classed as flat when price is in the cloud.
Furthermore, a bullish trend is considered to be strengthening when the orange cloud line is above the pink cloud line. Similarly, a bearish trend is considered to be strengthening when the orange cloud line is below the pink cloud line.
So, taking this into consideration means that essentially traders can look to buy price as the cloud turns orange and look to sell price when the cloud turns pink. Furthermore, the cloud can simply be used as a guide for trend direction, allowing the trader to use their own technical setups to enter the market.
For example, if the cloud is bullish then traders can look to buy breakouts beyond resistance levels or look to buy as RSI or Stochastics register oversold conditions. Similarly, if the cloud is bearish traders can look to sell breakdowns through support or look to sell as momentum indicators register overbought conditions.
Tenkan Sen & Kijun Sen Line signals
Within a bullish trend, as dictated by the price being above the cloud and the cloud being orange, we can look for periods where the Tenkan Sen Line dips below the Kijun Sen line and then crosses back above – this gives us a bullish entry signal in line with the trend.
Similarly, when the price is moving in a bearish trend, as dictated by price being below the cloud and the cloud being pink, we can look for periods where the Tenkan Sen line crosses above the Kijun Sen line and then falls back below, offering us a bearish entry signal.
Price & Kijun Sen
We can also identify signals based on the relationship between price and the Kijun Sen line. When the price is moving in a bullish trend, as dictated by price being above the cloud and the cloud being orange, we can look for periods where price dips below the Kijun Sen line and then crosses back above, giving us a bullish entry signal.
Again, for a bearish setup, we would wait for a bearish trend to develop, as dictated by price moving below the cloud and the cloud being pink. We then look to identify periods where price crosses above the Kijun Sen line and then falls back below
As you can see, although the indicator might look quite complicated at first, the signals it gives are actually very simple and straightforward to follow. The indicator is typically used in trend following and helping traders find entry to trending markets so you might find that during choppy, range-bound conditions the indicator readings don’t perform as well.
As with all indicators, it is important to identify which conditions they are best suited to and which conditions present the biggest challenge, you can then look maximize on favorable conditions and reduce risk during more difficult market conditions.