Trading with the Ichimoku Cloud

By Robert Deadman, TSAgroup.com

March 24, 2016

Over the decades, many trading systems and methods have come and gone. Trading systems often fail as markets change, volatilities change, politics change, and players change. With all of these changes, it's often surprising that any trading methods have been able to perform for any real time at all.

Yet, there is one trading method that has remained profitable, not just for months or years, but for decades. It seems that one of the oldest trading methods around, to this day, is still one of the most reliable. This system, known to the West simply as Ichimoku, or by its longer name of Ichimoku Kinko Hyo, has been successfully traded for almost 5 decades ever since its release.

The History of Ichimoku

The history of the Ichimoku begins back in the 1930's when Tokyo newspaper journalist “Ichimoku Sanjin” (real name: Goichi Hosada) began studying price charts trying to figure out if there were patterns in the markets. Over the course of the next 30 years, he and various assistants would go over chart after chart, testing ideas and looking for behaviors that shows signs of consistency and probability. At the time, Japanese Candlesticks were the primary trading tool of the markets in Japan. In 1968, Goichi Hosada released his methods to the public. Since then, in Japan, the method has been a staple in Japanese trading.

In the 1990's, the Ichimoku methods arrived in the western world, but it wasn't until the 2000's that it began growing in popularity. In this time, many people have grabbed this bull by the horns, but more than that have had difficulty understanding and/or implementing it. While the concepts behind it are simple, the collection of information that the Ichimoku provides can be overwhelming and difficult to take action by.

Ichimoku Kinko Hyo

The concept behind Ichimoku is that it is primarily a trend following method comprised of averages, not of price, but of ranges, and of shifting some of those ranges around on the chart.

An example of an Ichimoku chart on the USDJPY foreign exchange pair. (Chart courtesy of MetaStock)

The full term of this method is called “Ichimoku Kinko Hyu” and roughly translates to “Equilibrium at one look.” The method is based around 5 primary components (represented as indicators) working together to create a picture as to what is happening at this moment on the chart. The components are as follows:

Tenkan Sen

The Tenkan Sen, or Turning Line, is the fastest moving component and tracks close to price. It is based at the midpoint of the highest high and lowest low for the last 9 periods.

Kijun Sen

Kijun Sen is the Standard Line, and is used as a support/resistance line, but also as a stop loss value for keeping a trailing stop when desired. It is calculated the same way as the Tenkan Sen, but for the last 26 periods instead of 9.

The relationship of the Tenkan Sen to the Kijun Sen is one of the Ichimoku method's primary entry signal components.

Senkou Span A and B

The difference between the two Senkou Span indicators creates the Ichimoku Cloud, otherwise known as the Kumo. This is a chart's point of equilibrium. As prices move away from the Kumo, trends can occur, but eventually will fall back into the range of the Kumo.

The Senkou Span A is the midpoint of the Tenkan Sen and the Kijun Sen, shifted 26 periods forward.

The Senkou Span B is the midpoint if the highest high and lowest low for the last 52 periods, shifted 26 periods forward.

Chikou Span

This indicator is simple but surprising powerful. It is the current closing price shifted 26 periods backward. Its value is in its relationship to past prices and the Kumo. The value that the Chikou Span is in relation to price 26 periods ago is an indication of trend direction, but when it's the same value as 26 periods ago, that refers to a stagnant market that isn't changing significantly.

The Ichimoku Cloud, Tenkan Sen, Kijun Sen, and Chikou Span indicators labeled on a chart. (Chart courtesy of MetaStock.)

Trading the Ichimoku Method

There is more to Ickimoku trading than can be shown in this article, but the basics will be shown here so that an understanding of the power of the method can be seen.

In general, Ichimoku is a method, rather than a system. This means that the components for determining entries and exits are dynamic. A decision is not made on a single indicator or signal, but instead by taking a big picture view as to what the chart is doing. Only by stepping back and seeing all that is happening can a valuable trading decision be made.

Even though a big picture is required, there are still primary and secondary signals that are used to make the big picture decisions. Here are the predominant signals according to the method.

The TK Cross

Though there are many signals within Ichimoku, The TK Cross signal is one of the two most prolific signals there are. A signal is generated when the Tenkan Sen crosses above the Kijun Sen for long conditions, or when the Tenkan Sen crosses below the Kijun Sen for short conditions.

The TK Cross shows where there is a change in short-term trend, but where the cross occurs matters as well. A bullish cross can have different meanings depending on whether it crosses below, within, or above the Kumo. A bullish cross below the Kumo may be the start of a new upward trend, but often shows a retracement waiting to go bearish again. This is called a “weak” TK Cross, and usually if it is acted upon, it is typically used to exit a long position.

When a Bullish TK Cross occurs above the Kumo, this is often tied to a retracement condition toward the Kumo that is now going back up. For many, this is a re-entry signal in the long direction and is called a “strong” TK Cross.

When the TK cross occurs inside the Kumo, this is called “neutral”, as it is usually a holding position waiting for another signal.

The Price/Kumo Relationship

The other predominant signal is where the price closes in relationship to the Kumo. As the Kumo is the equilibrium point, trends are viewed as expansions away from, or contractions towards, the Kumo. Price movements away from the Kumo show trend movement, but the equilibrium point of the Kumo will follow the price, acting as the position that price ultimately wants to converge towards.

Though some modern and advanced trading tactics show methods to placing trades opposite of the Price/Kumo relationship, the base components of the Ichimoku System involve placing trades in the direction that price is to the Kumo. So, if prices are above the Kumo, then only long positions would be taken, and prices below the Kumo have only short positions taken.

The TK Cross and the Price/Kumo Relationship

As these two trading concepts are key, neither one of them is intended to be used alone, and they should be looked as dependent upon each other.

Initially, the Price/Kumo relationship is looked at to see what side (if any) the price of the Kumo. If the price is above the Kumo, then only long positions would be considered. As price begins to expand and close above the Kumo, then the TK Cross is examined. If the last TK Cross was a bullish one (even if it occurred below or inside the Kumo), then this would qualify as a long signal. If, however, the most recent TK Cross was a bearish one, then you would wait for a bullish TK Cross signal to occur. The important point here is that the Tenkan Sen is above the Kijun Sen AND the price is above the Kumo at the same time. The reverse would be true for a short position.

TK Cross and Price/Kumo Relationship Signals (Chart courtesy of MetaStock)

Seeing the Future

The Kumo doesn't just show current equilibrium, but also where the equilibrium point in the future is going to be. Seeing this allows you to know how close or far prices will have to move to break into the cloud. As the cloud is the equilibrium point, it is the position where trades are ended and new trades started, and knowing it's future position can allow a trader foresight as to where protective measures should be set.

Technically, the direction of the Kumo would not be taken into consideration for trend direction. However, most traders have seen that it is often best to place trades in the future direction of the Kumo, as this is seen as a representation of future price direction.

Seeing the Past

The Ichimoku Method includes a very powerful indicator in its simplicity. The Chikou Span is simply the current closing price plotted 26 periods in the past. This is a quick measure to see where current prices are in relation to prices 26 periods ago. Though this could be thought of as a basic 26 period Rate-of-Change indicator, the value is important not just to the previous closing prices, but also to the previous highs and lows. As prices begin to stabilize, the Chikou Span starts to intertwine inside the highs and lows 26 periods ago, showing clearly that the prices are range bound or even stagnant.

While this doesn't constitute a message for trades that are already in play, it is clear that when the Chikou Span is moving inside the prices that new trades should not be placed in any direction, and that you should wait for the Chikou Span to exit the price range to take new trades, with new trades ideally being taken in the direction of the breakout.

The Kumo is extended 26 Periods into the future. The Chikou Span as set 26 Periods into the past. (Chart courtesy of MetaStock Xenith)

Along with the Chikou Span's relation to price, the Chikou Span's relation to the Kumo is also considered important, as it references the current prices related to the Kumo's measurement of equilibrium. As with Chikou Span vs. Price, the same rules apply to its relationship to the Kumo, with breakouts of it having a similar meaning. This rule is not often followed among westerners as it often doesn't seem to make sense to compare the current price to a historical perspective. Never the less, it is a factor in the Ichimoku process.

The Advantages and Disadvantages of Ichimoku

Every trading method has benefits and detriments. When searching for a strategy, the general idea is to find a system where the benefits and successes outweigh the detriments so that overall, a profit can be made in a way that makes sense to the trader and works with their way of thinking about the markets.

Advantages of the Ichimoku Method

One of the best advantages to the Ichimoku Method is that it has held up over time. At around 50 years since its release, it is still heavily used and promoted as a very valuable system. Even groups who test with different parameters for the indicators keep on coming back to the default, showing that there is little improvement when trying to change such a well-made system.

The other main advantage is that the Ichimoku Method is excellent in its trend participation. While there are false entries (as with any system), it does incredibly well with getting into an actual trend. Because of this, many traders accentuate their Ichimoku trading with position-scaling techniques to capture more profit from existing trends.

A third advantage is its consistency with certain markets. Forex and commodity traders have great success using Ichimoku with the high-volume instruments since they are usually highly trended.

Disadvantages with Ichimoku

As with any system, there are some drawbacks.

A very busy chart. While all of the indicators convey a great deal of information, many people can have difficulty in determining values and positions as those indicators intertwine with price. Interpretive software can break through the visual chaos and give clear information quickly.

Not all rules work across all time-frames. As a chart moves to smaller and smaller timeframes, the more intricate rules of Ichimoku tend to cause whipsaws. On significantly short timeframes, many people move to just the future Kumo direction to determine their trades as adding in other indicators can cause too much loss among commissions and spreads.

Difficult to look at historically with the shifted values. When looking at an historical chart with the Ichimoku indicators applied, it is difficult to quickly gauge where the Kumo and the Chikou Span are in relation to the data being looked at since the indicators are shifted in opposite directions. Again, interpretive software can solve this problem by letting the trader see exactly where everything is in relation to each other.

No real stop and exit criteria defined. Ichimoku has several suggested stop-loss areas, but they change as the chart changes over time. When trading close to the Kumo, the Kumo itself is often used as the stopping area. When trading far from the Kumo, the Kijun Sen is typically used to lock in profits. These values aren't exact, as the stops are usually suggested around these areas if directly on them is uncomfortable for the trader. Many traders also consider a TK Cross in the opposite direction of a trade as an exit rule.

Advanced Techniques

One of the most fascinating aspects of Ichimoku is how so many other traders have tried to improve on it. Most researchers and system developers end up coming back to the basics after rigorous design. Every once in a while, someone will figure out how to tweak a rule a little bit, even if it's something that works only for a specific security. These tweaks have sometimes been shown to be very profitable.

As with any trading system or method, feel free to experiment with the signals to find something that works for you and with your trading style. Only with time and experience can you get a feeling if the Ichimoku Method is for you, as so many other traders have found that it certainly is for them.

Additional Resources

While the Ichimoku is a useful indicator, new users can find that keeping track and learning the indicators can be quite complex.   To assist users with this, we’ve built a MetaStock add-on that will help:

  • Alert users to Bullish and Bearish opportunities
  • Keep track of the bullish/bearish orientation of the six primary Ichimoku Signals
  • Identify key levels of support/resistance using the Kaijun and Kumo
  • Provide detailed information about the indicators
  • Scan entire markets to find the best current entry signals

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ABOUT THE AUTHOR

Robert Deadman

Author: Robert Deadman, Founder
Company: Trading Systems Analysis Group
Website: TSAgroup.com
Services Offered: Trading Software, Data Feed Service
Markets Covered: Stocks, Options, Futures, Forex

Robert James Deadman has been involved in trading analysis since 1985 and he has covered research in many areas including statistical analysis, artificial intelligence, and machine learning.

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