TRADING THE ICHIMOKU KINKO HYO
“Ichimoku” is a Japanese word that means “one look.” With one look, chartists can identify the trend and look for potential signals within that trend. This charting technique was created by a Japanese newspaper writer, Goichi Hosada. He spent thirty years perfecting the technique before releasing his findings to the general public in the late 1960s.
What is Ichimoku Indicator?
It is a technical indicator that a trader can use to gauge an asset’s trend, momentum and support and resistance points without the need of any other technical indicator.Ichimoku comprised of five lines, as follows:
- Tenkan sen
- Kijun sen
- Chikou span
- Senkou Span A
- Senkou Span B
Unlike typical simple moving average, where the day’s closing price is taken and calculated, Tenkan sen is calculated as (HIGHEST HIGH + LOWEST LOW)/2 for the past 9 periods
The Tenkan Sen is an indicator of the market trend. If the Tenkan sen is moving up or down, it indicates that the market is trending. If it moves horizontally, it signals that the market is ranging. The sharper the angle of the Tenkan sen line, the stronger the trend while the flatter the Tenkan sen line, the slower the momentum of the move. Notice that it follows price action the closest.
Kijun sen is calculated using (HIGHEST HIGH + LOWEST LOW)/2 for the past 26 periods.
The Kijun Sen acts as an indicator of future price movement. If the price is higher than the Kijun sen, it could continue to climb higher. If the price is below the Kijun sen, it could keep dropping. Notice that it trails the faster Tenkan sen, but follows price action pretty well.
Moreover, since Kijun sen line uses a longer period of time to gauge price action, it is a more reliable technique for defining the direction of the trend than the Tenkan sen line. And since the price is akin to this line during a strong trend, it can act as a stop loss for traders already in the correct direction of the trend. Hence, the trend ends when the price breaks or closes below it by a substantial quantity.
Applications of the Tenkan and Kijun
The most common application of the Tenkan and Kijun lines are the ‘cross’ referred to as the Tenkan-Kijun Cross.
An upward cross means a possible upward trend while a downward cross implies a possible downtrend. A generic upward cross can be used as a generic bullish signal and a generic downward cross can be used as a generic bearish signal.
Goichi Hosada went even further to give another definition of the cross based upon its position in relationship to the cloud.Weak Cross:
It is considered a weak signal if the cross is below the Kumo; since the cross is below resistance.Medium Cross:
It is a medium signal when it happens inside the Kumo; the cross occurs within the field of support/resistance.Strong Cross:
The strongest signal is when the cross occurs above the Kumo for a bullish cross, or a bearish cross below the Kumo. This is because the cross is occurring after the price action has cleared the support or resistance – that being the Kumo.
The vice versa is true for the bearish signals.
This is shown on the chart as a lagging line behind the price. In the chart below, it is the green dotted line and it is calculated as CURRENT CLOSING PRICE time-shifted backwards (into the past) 26 periods.
Chikou Span is one of the unique feature of Ichimoku.
Why is Chikou Span shifted 26 periods back? The answer becomes clear once you understand that a change in trend is a relative state. For example, if the trend is up and it continues to go up, then there is no change in trend. By shifting it backwards 26 period, we can compare the current price level to how it looks like, 26 periods ago.
With a glance of the position of the current price level and Chikou Span, we can quickly identify if the trend is changing and is it going to break through any possible support or resistant levels.Some rules:
- If current close price is higher than that of Chikou Span at 26 periods ago, then we can safely say that the likelihood of more bullish price action to go and vice versa.
- If Chikou Span cuts through the price line with no kumo resistant in sight, we can assume that the trend is bullish.
- If Chikou Span cuts through the price line with kumo resistant ahead, we can expect resistant levels.
Senkou span A is calculated as (Tenkan-sen + kijun-sen)/2 plotted 26 periods ahead.
Also called leading span 1, this line forms one edge of the kumo, or cloud.
If the price is above the Senkou span, the top line serves as the first support level while the bottom line serves as the second support level.
If the price is below the Senkou span, the bottom line forms the first resistance level while the top line is the second resistance level.Senkou span B
Senkou span B is calculated as (highest high + lowest low)/2 calculated over the past 52 time periods and plotted 26 periods ahead.
Also called leading span 2, this line forms the other edge of the kumo.
The Cloud (Kumo) is the most prominent feature of the Ichimoku Cloud plots. The Senkou Span A (green) and Senkou Span B (red) form the Cloud.
There are two ways to identify the overall trend using the Kumo. First, if the price is above the Kumo, then there is an uptrend in place and/or more buying opportunities; and if the price is below the Kumo, then it is under resistance and it is better to be looking for shorts instead of longs; and if the prices are in the Kumo, then it is flat. Second, the uptrend is strengthened when the Senkou Span A (green cloud line) is rising and above the Senkou Span B (red cloud line). This situation produces a green Cloud. It is important to remember that bullish signals are reinforced when prices are above the cloud and the cloud is green.
Conversely, a downtrend is reinforced when the Senkou Span A (green cloud line) is falling and below the Senkou Span B (red cloud line). This situation produces a red Cloud. Remember, the entire Cloud is shifted forward 26 days. This means it is plotted 26 days ahead of the last price point to indicate future support or resistance. It is important to remember that bearish signals are reinforced when prices are below the cloud and the cloud is red.
The longer price action stays above or below the Kumo, the stronger the trend and the more support/resistance the Kumo offers. The farther the price action is from it, the stronger the trend and more volatile it is.
How can we use Kumo for Reversals?
If the price is clearly above or below it, then when price action breaks the kumo, it can often signal a reversal.
Signal SummaryBullish Signals:
Price moves above Cloud (trend)
Cloud turns from red to green (ebb-flow within trend)
Price Moves above the Kijun sen (momentum)
Tenkan sen moves above Kijun sen (momentum)
Price moves below Cloud (trend)
Cloud turns from green to red (ebb-flow within trend)
Price Moves below Kijun sen (momentum)
- Tenkan sen moves below Kijun sen (momentum)
The Ichimoku Cloud is a comprehensive indicator designed to produce clear signals. Chartists can first determine the trend by using the Cloud. Once the trend is established, appropriate signals can be determined using the price plot, Tenkan sen and Kijun sen. The classic signal is to look for the Tenkan sen to cross the Kijun sen.
The Ichimoku Cloud can also be used in conjunction with other indicators. Traders can identify the trend using the Cloud and then use classic momentum oscillators to identify overbought or oversold conditions.