The Best Trend Trading Indicators: Ichimoku Cloud
One of the more popular and sophisticated forex indicators is the Ichimoku Kinko Hyo, or Ichimoku.
Its name describes its function as it translates to “one look equilibrium chart”. It’s a complex combination of calculations that shows you the most important trading information of the forex market in one glance.
Although it looks really complicated, it’s quite logical in construction and easy to understand. It’s very popular especially among web acting forex analysts.
This is because aside from being generally useful in pretty much most FX trading scenarios, it also looks really cool! So, here’s how to get the most out of it.
The Nuts and Bolts
Ichimoku was developed in the late ’60s by a journalist, not an FX trader. At the time, forex wasn’t a widespread practice, and the indicator was mostly oriented towards stocks, which usually trend in a direction over an extended time.
It works best in forex under similar conditions, in longer-term charts.
Unlike other forex trading indicators developed after computers, it doesn’t use moving averages. It uses the median between high and low over time.
This calculation of 9 of the period highs plus 9 of the period, then divided in half (the average) forms the basis of the indicator: the conversion line.
From there, using high and low averages instead of a moving average, Ichimoku works similar to most of the other forex indicators. Most notably MACD, by comparing faster (shorter-term) averages to longer-term averages.
A distinctive feature of the FX indicator is the “cloud.” This is a shaded area that is often in front of the market price. This gives the look that it’s predicting the market’s direction, and is a nice visual aid.
We do this by displacing the moving high low calculation forward, unlike “traditional” moving averages that place the line at the current market price.
How to Read the Ichimoku
The basic idea is to identify the trend. When the market price is above the cloud, it’s trending upwards. When it’s below the cloud, it’s trending downwards.
Because it doesn’t use a single cross-over line, the argument is that Ichimoku gives a stronger reading of the trend. Of course, when the trend reverses, the price action has to move towards the cloud before crossing through it and showing the new trend.
Generally, when the trend is upwards, the cloud is plotted as green. When the trend is downwards, it’s red.
The Other Information
Signals generate when price action emerges from the cloud. So, a buy when it moves above, and a sell when it goes below.
We see this as an indication of a new trend being created. Note that the periods Ichimoku uses are the same as those that MACD uses. The latter also employs a crossover pattern to indicate a new trend formation.
Forex traders often use the “forward” projection of the cloud to determine support and resistance levels. This depends on the market’s direction, though. The logic here is that the cloud represents the “area of uncertainty” in which the trend is more likely to switch direction.
So, if the price action has moved through the cloud, you can be sure that the market has moved beyond its support or resistance level.
Ichimoku is a good, all-round forex indicator. It shows the trend, support and resistance levels as well as market momentum. It’s a great tool to get a quick understanding of the market.
But, unlike what it was designed to do, it’s always better to have at least two indicators when trying to read the forex market. But probably not the MACD because of the similarities between the two!