What is the Ichimoku Cloud trading strategy and how to use it?
The Ichimoku Cloud Trading Strategy is a Japanese candlestick charting technique for determining if the current trend of a certain asset will continue.
In this article, we will introduce you to the Ichimoku indicator, explain what it consists of, and how you can use it in trading. It is one of the most popular technical indicators used by traders worldwide, and while it may look complex at first look, it can give traders valuable information.
What is the Ichimoku Cloud?
The Ichimoku Cloud - also known as Ichimoku Kinko Hyo - is a popular technical indicator that was developed by journalist Goichi Hosoda in the 1930s. It was not released to the public until 1969 but is still very commonly used by traders worldwide today. The indicator remains very popular in Japan, and there is a theory that it works better when applied to the Japanese Yen currency pairs and the Nikkei, as those are the most widely traded instruments in Japan.
Translated into English, the name of the indicator is "One glance equilibrium chart" as traders can derive a variety of information from it.
What does the Ichimoku Cloud look like when plotted on a chart?
The indicator can appear complex at first and traders who prefer to keep their charts "clean" to prevent information overload might have doubts about it. However, the Ichimoku indicator tells us quite a lot, and there is no need to use too many additional indicators.
How does the Ichimoku Cloud work?
A trader should understand all of the components that make up an Ichimoku chart before they can execute it successfully as a part of their technical analysis.
Ichimoku Cloud explained:
- The Tenkan-sen: The sum of the 9-period high and 9-period low, divided by two.
- The Kijun-sen: The sum of the 26-period high and 26-period low, divided by two.
- Senkou Span A: The sum of the Tenkan-sen and Kijun-sen, divided by two. In other words, it represents the midpoint of the two lines and the upper line of the cloud.
- Senkou Span B: The sum of the 52-period high and 52-period low, divided by two. This represents the lower line of the cloud.
- Chikou Span: Shows closing prices 26 periods behind the latest closing price of an asset.
- Kumo/Cloud: The space between Senkou Span A and Senkou Span B.
How to use Ichimoku Cloud for trading?
Find out below how each part of the Ichimoku Cloud can contribute information when plotted on a chart.
The Cloud
Using the Ichimoku indicator, a currency pair is in an uptrend when the price is trading above the cloud and the cloud is in green territory. On the other hand, a currency pair is in a downtrend when the price is trading below the cloud and the cloud is in red territory.
Trend followers who use this indicator will generally only consider long trades when it shows an uptrend and only consider short trades when it shows a downtrend.
The cloud also indicates the level of volatility. Large price movements will lead to a thicker cloud, while a period of consolidation will create a thinner cloud.
In the example below, we can see that the cloud started to widen in early June, which marked the beginning of a period of high volatility. Price broke below the cloud in early August and USOIL collapsed shortly after that.
Chikou Span
Some traders use the Chikou Span as an additional confirmation of the trend (i.e. the line crossing the price in the bottom-up direction can be seen as a buy signal, while the line crossing the price from the top-down may be seen as a sell signal).
Senkou Span
If the price is above the Senkou Span, traders look at the top line as the first level of support, followed by the bottom line as the second level of support.
If the price is located below the Senkou Span, traders look at the bottom line for the first level of resistance, and the top line as the second level of resistance.
Tenkan/Kijun Crossover
Some traders use the Tenkan/Kijun cross for additional confirmation or even for trade signals when a crossover occurs. Below are 3 examples of a cross.
Ichimoku trading strategies
Here we will show you two different Ichimoku Cloud trading strategies - one bullish example and one bearish example.
One popular strategy is the Ichimoku Cloud breakout strategy.
A trader would buy once the price breaks through the cloud or sell once the price goes below the cloud.
Below is a bearish example of this strategy. We are looking at GBP/JPY. The price broke below the cloud in mid-August and the currency pair extended losses by more than 300 pips. Traders using this strategy will often wait for a Tenkan/Kijun cross as an exit signal. That cross could signal that the short-term downtrend has ended and there is no more room for the downside.
Below is an example of how we could use the Tenkan/Kijun cross in trading.
US500 is in a strong uptrend and the price is located above the cloud. We will therefore be looking for buy opportunities.
In mid-May, there was a bearish cross followed by a bullish cross one week later. We would have ignored the bearish cross as the US500 is in a strong uptrend and trading above the cloud.
The bullish cross would have been a valid entry signal, however, as we can see, the US500 has extended gains significantly since then. As an exit point, you could have used classic support/resistance levels or waited for another bearish cross to happen.
How to add the Ichimoku Cloud indicator in MT4?
Follow the steps below to add the Ichimoku Cloud indicator to your trading chart in MetaTrader 4.
- Open the MetaTrader 4 trading platform
- Click on the green plus sign in the menu highlighted below
- Select "Trend" with your mouse and click on "Ichimoku Kinko Hyo"
- A new window will appear with the parameters, colours, and visualisation settings
- By default, the Tenkan-sen will be set to 9, the Kijun-sen to 26, and the Senkou Span B to 52
- You may adjust these settings, but the above-mentioned combination is most commonly used
What is the best time frame for the Ichimoku Cloud indicator?
The Ichimoku Cloud indicator can be used in any time frame, and there is no "best" one. It all depends on what type of trader you are. Day traders might prefer to use the Ichimoku on the M5 or M15 chart to help them identify the trend and/or get entry and exit signals. Swing traders could prefer to place the Ichimoku on the H4 or Daily chart instead and determine the trend and key support/resistance with it.
However, you should be aware that the Ichimoku indicator works best when the market is trending - and this applies to all time frames.
Which other technical indicators work best with the Ichimoku strategy?
We can already derive a variety of information from the Ichimoku indicator, and it can be used for entry/exit signals too. Therefore, it is not required to use many additional indicators together with the Ichimoku Cloud, as it could create conflicting signals. However, traders might choose to add an oscillator to their charts, which can signal overbought and oversold conditions. It is also worth keeping an eye out for divergences between the price and the oscillator. Traders may use the RSI, the Stochastic, or the MACD indicator for this purpose.
Below is a chart of the AUD/USD currency pair with both the Ichimoku and the MACD indicators.
Advantages and disadvantages of the Ichimoku Cloud strategy
Pros
- Variety of Information: the Ichimoku Cloud indicator can help us determine the trend, support, resistance levels, and momentum.
- Cutting Down the Number of Indicators: While the Ichimoku Cloud indicator does take up quite some space on the chart, it will reduce the number of indicators you will need overall, which means that there is less risk of receiving conflicting signals.
Cons
- Information Overload: Beginners might find themselves overwhelmed by the amount of information given by the Ichimoku Cloud indicator. It will take some time to learn what all its components represent and how to use them efficiently.
- Chart Space: Traders that prefer to keep their charts clean and focus on price action might struggle to get used to the Ichimoku Cloud indicator.
Conclusion
The Ichimoku Cloud indicator may appear to be complicated at first look, but once a trader is aware of what each of the components represents and how to use it, it can be a useful tool as it displays a variety of information which reduces the need for additional indicators.
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.
