An introduction to what the Ichimoku trading strategy is

Trading requires not only hard work but also a strategic approach. We assume you have utilized several techniques, but have you tried the Ichimoku trading strategy? Below we shall explain what it is and how you can apply the method in your trading journey.

Origin and definition of Ichimoku

Ichimoku Kinko Hyo, or Ichimoku for short, is a technical indicator analysis method that originated in Japan. Ichimoku means a glance or one look, Kinko means equilibrium or balance, and Hyo is a chart. The technique came to the public’s attention in the 1960s after Japanese analyst Goichi Hosoda, also known as Sanjin Ishimoku, released it. He had spent almost three decades perfecting the indicator before the public could utilize it.

Ichimoku is designed to provide a comprehensive look at the market trend, as well as potential areas of support and resistance. It is one of the most comprehensive technical tools, and forex and stock traders all over the world have swiftly adopted it as their go-to indicator. Ichimoku is based on the idea that the trend can be determined by analyzing the past and present and that the future can be forecasted using this information.

It, therefore, helps determine the most suitable time to enter and exit the market by providing the trend direction as well as showing the strength of these markets’ signals. Since all this information is offered in one chart, using the Ichimoku cloud can be the best strategy to use for intraday trading.

Components of the Ichimoku

The Ichimoku is made up of five main components, which are very crucial and helpful for market analysis. These lines provide you with signals to rely on to make accurate forecasts.

1. Tenkan-sen (Conversion Line)

This line is used to identify the short-term trend. It is calculated by summing the highest high and the lowest low for the past nine periods and then dividing the result by two.

Its formula is:

TS = (9PH + 9PL) / 2,

where:

• PH – Period High;
• PL – Period low.

2. Kijun-sen (Baseline)

Kijun-sen is used to identify the medium-term trend. It can be calculated by taking the highest high and the lowest low for the past 26 periods and then dividing the result by two.

Here is the formula:

KS = (26PH + 26PL) / 2

Interpreting the Kijun-sen and Tenkan-sen

You can use the Kijun-sen and Tenkan-sen to initiate a trading position using a moving average crossover. When you see a crossover in these two lines or, in short, an intersection as the lines move downwards, the decline signifies a downtrend. This decline indicates that short-term prices are falling below the longer-term price trend.

In other words, when the Tenkan-sen crosses the Kijun-sen from below, it is considered a bullish signal, and when the Tenkan-sen crosses the Kijun-sen from above, that is a bearish one.

3. Senkou Span A (Leading Span A)

This line is used to identify potential areas of support and resistance. Its calculation involves taking the average of the Tenkan-sen and the Kijun-sen and then plotting the result 26 periods ahead:

SSA = (TS+KS) / 2

4. Senkou Span B (Leading Span B)

It is also used to identify potential areas of support and resistance. You can calculate the line by taking the highest high and the lowest low over the past 52 periods and then dividing the result by two:

SSB = (52PH + 52PL) / 2

Formation of the Ichimoku cloud

The area that forms between the Senkou Span A and Senkou Span B is what is known as the Ichimoku cloud or Kumo. It represents the recent and past price action and acts as support and resistance by erecting formative barriers. The cloud narrows down (filters) the number of options to choose from many securities. Hence, you can save a significant amount of time.

A Kumo cloud is thicker than the standard support and resistance lines, and this plays a vital role by providing an overview of the asset’s volatility instead of only providing the price level of the securities.

When the Senkou Span A is above the Senkou Span B, the cloud is bullish, indicating that there is likely to be an uptrend. When the Senkou Span A is below the Senkou Span B, the cloud is bearish, indicating a downtrend probability. Crossing these lines is also known as the Kumo twist, and it is the best trading strategy for swing traders when using the Ichimoku. Also, a breakout through the cloud, followed by a move above or below it, indicates a better and more likely trade.

5. Chikou Span

Another important piece of the Ichimoku chart is the Chikou Span. It is calculated by plotting the current closing price 26 periods behind. It generally forms a certain idea or attitude in traders about how the currency market is by showing the asset’s trend and its relation to the closing price momentum.

You will know that the trend is bullish if the last 26 periods depict upward movement (the Chikou span hovering above the price action); hence, you can execute a buy position. If the past 26 periods show a downward motion (the span hovering below the price action), that is a downtrend, indicating a bearish market; hence you can find a selling position. 

How to trade Ichimoku trading strategy?

To understand the Ichimoku, we shall look at the currency pair scenario on a chart.

As you can see, the pair moved between the 116 and 119 range and formed an Ichimoku cloud within the first four months. The cloud creates a very strong support and resistance barrier. Let us have a little interpretation of the chart.

The Kijun-sen and Tenkan-sen

Kindly note that the Kijun-sen is the baseline, while the Tenkan-sen represents a short-term moving average (MA). When these two indicators combine, they behave like a moving average crossover. You can notice this after seeing the Tenkan-sen intersecting the Kijun-sen as it moves down – this is an indication of a price action decline. However, since our chart’s crossover occurs inside the cloud, the signal is still hazy and must leave the cloud before an entry can be taken into consideration.

The Chikou span

The Chikou (lagging span) in our figure is below the price action, and it has remained there for quite some time, which suggests a bearish sentiment. The market could be bullish if the span were above the price action.

Since the Tenkan, Kijun, and Chikou spans have confirmed a bearish trend, we should eye for short (sell) positions for our currency pair.

The cloud

The cloud forms the support and resistance barrier; therefore, observing a close session beneath the cloud would do good before taking any sell position. Using the Ichimoku cloud is one of the simplest day trading strategies since you only need to observe if the candlestick breaks through it.

A buying signal occurs when the candlestick from below the cloud breaks and closes above the Senkou Span A, and a selling signal occurs when the candlestick crosses the Kumo from above and closes below Senkou Span A.

In our chart, 114.56 represents the currency pair’s support level giving a good entry point. Also, you can find an entry position a few points below 114.56, which would confirm that the currency’s momentum is still in a downtrend.

You will also need to look for a stop-loss position which would help control the price movement if the momentum remains. In our chart, 116.65 would serve the purpose. Note that the price action should not move above the stop position to minimize risk.

A summary of the Ichimoku chart

We can summarise the Ichimoku trading strategy using the below four points:

1. A crossover of the Kijun and Tenkan-sens

These two lines act as a moving average. When they intersect, you can quickly know the trend of the market. When Tenkan-sen crosses over the Kijun-sen, it’s a buy signal, and when the Tenkan-sen falls below the Kijun-sen, it is a sell signal.

2. Confirmation of the market trend using the Chikou Span

The Chikou span provides the market sentiment. Because it functions similarly to a momentum oscillator, it increases the likelihood of the trade by confirming that market sentiment is in line with the crossover.

3. The breakout of the price action through the Kumo

The upcoming downtrend or uptrend should clearly break through the “cloud” of support or resistance. This option increases the likelihood that the trade will work to your advantage.

4. Money management

No trader wishes to lose but instead earn. One important thing to do is to follow strict money management rules. You can do this by considering a stop-loss position that will help you to balance the risk/reward ratio as you trade.

Let’s look at the main advantages of the cloud that make it so popular.

Benefits of the Ichimoku cloud

Here is why you should consider the Ichimoku cloud for your trading strategy:

1. The Ichimoku Cloud is a versatile tool for investors and traders since it can be utilized in any market and at any period.
2. It allows making informed decisions with little information as it provides a comprehensive perspective of the market by exhibiting many components of data on a single chart, including trend direction, support and resistance levels, and momentum.
3. The Ichimoku Cloud can be used to identify both short-term and long-term trends, making it a valuable tool for traders who trade multiple time frames.

Despite all of the above, the strategy has its downsides.

Limitations of Ichimoku

As with any technical indicator, there are certain limitations to be aware of when using a trading strategy with Ichimoku Cloud.

One limitation is that it is a lagging indicator, which means that the cloud is based on historical price data and may not accurately forecast future price movements.

Additionally, it does not provide any information about the underlying fundamentals of the asset being analyzed, which can be important in making trading decisions.

The Ichimoku can produce false signals, particularly in range-bound or low-volatility markets. It is advisable to use it in conjunction with other ones is advisable to confirm signals and reduce the risk of false ones.

Also, the Ichimoku Cloud is a trend-following tool, so it might underperform during trendless markets.

The bottom line

Ichimoku Kinko Hyo is one of the best strategies not only for intraday trading but also for the long term. Of course, it may be discouraging at first glance because the chart contains much information. You need to take your time and understand how the indicator works before applying any strategy. Also, use it along with other technical tools to confirm the signals and remember money management rules since trading is risky.