Introduction
The Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a versatile indicator that defines support and resistance, identifies trend direction, gauges momentum and provides trading signals. Ichimoku Kinko Hyo translates to "one look equilibrium chart". With one look, chartists can identify the trend and look for potential signals within that trend. The indicator was developed by Goichi Hosada, a journalist, and published in his 1969 book. Even though the Ichimoku Cloud may seem daunting on the price chart, it is really a straight forward indicator that is very usable. It was, after all, created by a journalist, not a rocket scientist! Moreover, the concepts are easy to understand and signals are well-defined.
Calculation
Four of the five plots within the Ichimoku Cloud are based on the average of the high and low over a given period of time. For example, the first plot is simply an average of the 9-day high and 9-day low. Before computers were widely available, it would have been easier to calculate this high-low average rather than a 9-day moving average. The Ichimoku Cloud consists of five plots:
Tenkan-sen (Turning Line): (9-period high + 9-period low)/2))
The default setting is 9 periods, but can be adjusted. On a daily
chart, this line is the mid point of the 9 day high-low range,
which is almost two weeks.
Kijun-sen (Standard Line): (26-period high + 26-period low)/2))
The default setting is 26 periods, but can be adjusted. On a daily
chart, this line is the mid point of the 26 day high-low range,
which is almost one month).
Senkou Span A (First Leading Line): (Turning Line + Standard Line)/2))
This is the midpoint between the Turning Line and the Standard Line.
The First Leading Line forms one of the two Cloud boundaries. It is
referred to as "Leading" because it is plotted 26 periods forward.
Senkou Span B (Second Leading Line): (52-period high + 52-period low)/2))
On the daily chart, this line is the mid point of the 52 day high-low range,
which is a little less than 3 months. The default calculation setting is
52 periods, but can be adjusted. This value is plotted 26 periods forward
and forms the slower Cloud boundary.
Chikou Span (Lagging Line): Close plotted 26 days ago
The default setting is 26 periods, but can be adjusted.
This tutorial will use the English equivalents when explaining the various plots. The chart below shows the Dow Industrials with the Ichimoku Cloud plots. The Turning Line (blue) is the fastest and most sensitive line. Notice that it follows price action the closest. The Standard Line (red) trails the faster Turning Line, but follows price action pretty well. The relationship between the Turning Line and Standard Line is similar to the relationship between a 9-day moving average and 26-day moving average. The 9-day is faster and follows the price plot closer. The 26-day is slower and lags behind the 9-day. Incidentally, notice that 9 and 26 are the same periods used to calculate MACD.
Analyzing the Cloud
The Cloud (Kumo) is the most prominent feature of the Ichimoku Cloud plots. The First Leading Line (green) and Second Leading Line (red) form the Cloud. The First Leading Line is the average of the Turning Line and the Standard Line. Because the Turning Line and Standard Line are calculated with 9 and 26 periods, respectively, the green Cloud boundary moves faster than the red Cloud boundary, which is the average of the 52-day high and the 52-day low. It is the same principle with moving averages. Shorter moving averages are more sensitive and faster than longer moving averages.
There are two ways to identify the overall trend using the Cloud. First, the trend is up when prices are above the Cloud, down when prices are below the Cloud and flat when prices are in the Cloud. Second, the uptrend is strengthened when the First Leading Line (green cloud line) is rising and above the Second Leading Line (red cloud line). This situation produces a green Cloud. Conversely, a downtrend is reinforced when the First Leading Line (green cloud line) is falling and below the Second Leading Line (red cloud line). This situation produces a red Cloud. Because the Cloud is shifted forward 26 days, it also provides a glimpse of future support or resistance.
Chart 2 shows IBM with a focus the uptrend and the Cloud. First, notice that IBM was in an uptrend from June to January as it traded above the Cloud. Second, notice how the Cloud offered support in July, early October and early November. Third, notice how the Cloud provides a glimpse of future resistance. Remember, the entire Cloud is shifted forward 26 days. This means it should be plotted 26 days past the last price point to provide indications for future support or resistance.
Chart 3 shows Boeing (BA) with a focus on the downtrend and the cloud. The trend changed when Boeing broke below Cloud support in June. The Cloud changed from green to red when the First Leading Line (green) moved below the Second Leading Line (red) in July. The cloud break represented the first trend change signal, while the color change represented the second trend change signal. Notice how the Cloud then acted as resistance in August and January.
Trend and Signals
Price, the Turning Line and the Standard Line are used to identify faster, and more frequent, signals. It is important to remember that bullish signals are reinforced when prices are above the cloud and the cloud is green. Bearish signals are reinforced when prices are below the cloud and the cloud is red. In other words, bullish signals are preferred when the bigger trend is up (prices above green cloud), while bearish signals are preferred when the bigger trend is down (prices are below red cloud). This is the essence of trading in the direction of the bigger trend. Signals that are counter to the existing trend are deemed weaker. Bullish signals within a bigger trend and bearish signals within a bigger uptrend are less robust.
Turning-Standard Line Signals
Chart 4 shows Kimberly Clark (KMB) producing two bullish signals within an uptrend. First, the trend was up because the stock was trading above the Cloud and the Cloud was green. The Turning Line dipped below the Standard Line for a few days in late June to enable the setup. A bullish crossover signal triggered when the Turning Line moved back above the Standard Line in July. The second signal occurred as the stock moved towards Cloud support. The Turning Line moved below the Standard Line in September to enable the setup. Another bullish crossover signal triggered when the Turning Line moved back above the Standard Line in October. Sometimes it is hard to determine exact Turning Line and Standard Line levels on the price chart. For reference, these numbers are displayed in the upper right of each Sharpchart. As of the January 8 close, the Turning Line was 62.62 (blue) and the Standard Line was 63.71 (red).
Chart 5 shows AT&T (T) producing a bearish signal within a downtrend. First, the trend was down as the stock was trading below the Cloud and the Cloud was red. After a sideways bounce in August, the Turning Line moved above the Standard Line to enable the setup. This did not last long as the Turning Line moved back below the Standard Line to trigger a bearish signal on September 15th.
Price-Standard Line Signals
Chart 6 shows Disney producing two bullish signals within an uptrend. With the stock trading above the green cloud, prices moved below the Standard Line (red) to enable the setup. This move represented a short-term oversold situation within a bigger uptrend. The pullback ended when prices moved back above the Standard Line to trigger the bullish signal.
Chart 7 shows DR Horton (DHI) producing two bearish signals within a downtrend. With the stock trading below the red cloud, prices bounced above the Standard Line (red) to enable the setup. This move created a short-term overbought situation within a bigger downtrend. The bounce ended when prices moved back below the Standard Line to trigger the bearish signal.
Signal Summary
This article features four bullish and four bearish signals derived from the Ichimoku Cloud plots. The trend-following signals focus on the Cloud, while the momentum signals focus on the Turning and Standard Lines. In general, movements above or below the cloud define the overall trend. Within that trend, the Cloud changes color as the trend ebbs and flows. Once the trend is identified, the Turning Line and Standard Line act similar to MACD for signal generation. And finally, simple price movements above or below the Standard Line can be used to generate signals.
Bullish Signals:
- Price moves above Cloud (trend)
- Cloud turns from red to green (ebb-flow within trend)
- Price Moves above the Standard Line (momentum)
- Turning Line moves above Standard Line (momentum)
Bearish Signals:
- Price moves below Cloud (trend)
- Cloud turns from green to red (ebb-flow within trend)
- Price Moves below Standard Line (momentum)
- Turning Line moves below Standard Line (momentum)
Conclusions
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, Turning Line and Standard Line. The classic signal is to look for the Turning Line to cross the Standard Line. While this signal can be effective, it can also be rare in a strong trend. More signals can be found by looking for price to cross the Standard Line.
It is important to look for signals in the direction of the bigger trend. With the Cloud offering support in an uptrend, traders should also be on alert for bullish signals when prices approach the Cloud on a pullback or consolidation. Conversely, in a bigger downtrend, traders should be on alert for bearish signals when prices approach the Cloud on an oversold bounce or consolidation.
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. Click here for a live example using the Ichimoku Cloud.
Ichimoku and SharpCharts
The Ichimoki Cloud indicator is available on SharpCharts by selecting it as an indicator in the "Overlay" dropdown box. Default settings are 9 for the Turning Line, 26 for the Standard Line and 52 for the Second Leading Line. The First Leading Line is based on the Turning Line and Standard Line. The number for the Standard Line (26) is also used to move the Cloud forward (26 days). These numbers can be adjusted to suit individual trading and investing styles. Sometimes it is necessary to add extra bars to the chart when increasing the Standard Line, which also increases the forward movement of the Cloud.
Source:http://stockcharts.com/
