In 1969 a book was published by journalist Goichi Hosoda. He described his technical indicator in it. The indicator is known as the Ichimoku Cloud or Ichimoku Kinko Hyo and is translated to “one look equilibrium chart” because you should be able to recognise the trend and catch a trading signal with one look at the chart. Let’s see what it is and how you can use it in your trading.
The basics of the Ichimoku Cloud
The Ichimoku Cloud is an indicator that can be used to identify the direction of the trend, the support and resistance levels, gauge momentum and get trading signals. It is a quite straightforward indicator although it may seem a bit complicated when you first look at it.
The Ichimoku Cloud lines
The Ichimoku Cloud consists of 5 plots. Four of them are based on high-low averages during a certain period of time. The indicator was developed many years ago before computers have become so popular and it was just easier to make calculations on the average of the high and low than a moving average.
Below you will find the Ichimoku Cloud attached to the price chart.
The first line of the Ichimoku Cloud is named the Conversion Line. Its default period is 9. If you take a daily chart it means that the Conversion Line is the midpoint of the 9-day high-low range. This is the fastest and most sensitive line of all.
The second line of the indicator is called the Base Line and its default period is 26. The relation of the Conversion Line and the Base Line is very similar to the relation between a 9-day moving average and a 26-day moving average.
The third line, the Lagging Span, is close plotted 26 days in the past (period of 26).
The last two lines, known as the Leading Span A and the Leading Span B make the cloud with two boundaries on the chart. The Leading Span A is the Conversion Line plus the Base Line divided by 2 and is the faster cloud boundary. The Leading Span B is 52-period high plus 52-period low divided by 2. It creates a slower cloud boundary.
All periods can be adjusted according to the trader’s needs.
The analysis of the cloud
The Ichimoku Cloud indicator allows you to recognise the trend. You should look where the cloud is created in relation to the price bars. If the cloud is above the prices, there is a downtrend. When the cloud is formed below the prices, there is an uptrend in the market.
The second thing you should check is the Leading Span A and B lines. During the downtrend, the Leading Span A is declining and lies under the Leading Span B. A red cloud is produced. In the uptrend, the situation looks quite the opposite. The Leading Span A is rising and moves above the Leading Span B creating a green cloud.
The cloud is 26 days ahead and so it gives a visual indication of future support and resistance levels.
Let’s take a look at the exemplary chart for the GBPUSD currency pair below.
The cloud changed its colour from green to red while the Leading Span A (green line) fell beneath the Leading Span B (red line). There is a downtrend in the market. The cloud also acts as resistance and provides a glimpse of the future resistance area.
How do you know there is an uptrend in the market? The Leading Span A moves above the Leading Span B and the cloud changes its colour from red to green. The cloud provides the support and indicates a future support area.
Trading along with the trend
The signals that are in accordance with the existing trend are much stronger than those that are counter to it. That is why you should look for the bullish signals during the uptrend, that is when the prices are above the green cloud. Expect the bearish signals when the prices are beneath the cloud which is red in colour.
Signals received from the Conversion-Base Line
To open a long position you should ensure there is an uptrend in the market. Check whether the prices move over the cloud and the colour of the cloud is green.
Now, consider the Conversion Line and the Base Line. A signal to go long is produced when the Conversion Line crosses the Base Line from below and continues above it.
A bearish signal should be searched for when there is a downtrend that is the prices are below the red cloud. The Conversion Line should move above the Base Line. You should open a short trade when the Conversion Line crosses the Base Line from above and moves further below it.
Signals received from the Price-Base Line
The bullish signals should be expected when the prices are above the cloud and the cloud is green. This means there is an uptrend. Now check where are the prices in relation to the Base Line. When they are below the Base Line and then move back above it, you get a signal to go long.
If you want to open a short position, wait for the prices to move below the cloud and the cloud should be red. Now, check the Base Line. You receive a trading signal when the prices bounce over the Base Line and then cross the Base Line on their way down.
The Ichimoku Cloud is a broad indicator that can be used to catch the best entry points for your trades. You can define the trend by looking at the cloud created by the Leading Span A and the Leading Span B lines. During the downtrend, the prices are below the cloud and the cloud is red. In the uptrend, the prices are above the cloud which is green in colour.
The momentum signals are produced by crossovers of the Conversion Line and the Base Line or the price bars and the Base Line.
The Conversion Line and the Base Line crossovers offer very strong signals however, they can be quite rarely spotted on the chart. The price and Base Line crossovers occur more often.
Remember to trade along with the trend.
You can combine the Ichimoku Cloud with other indicators. For example, you can use the cloud to identify the trend and then search for oversold and overbought areas with one of the classic momentum oscillators like the RSI.
I suggest you go directly to the Olymp Trade demo account to see how the Ichimoku Cloud works in a risk-free environment. Move to the live account when you feel confident catching the trading signals with it.
Do not forget to share your opinion on the Ichimoku Cloud with us in the comments section below.
Wish you an enjoyable trading experience!
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