Ichimoku: Trading Indicator

The indicator known as ichimoku is a quite interesting, effective and a little known indicator outside of Japan, Australia, New Zealand and Asia proper. But its use is quite effective simply because of its powerful moving averages that serve as strong lines of support and resistance and its cloud bottom and top  that serves as even more stronger lines of support and resistance. What makes this indicator quite interesting is that ichimoku is a very old indicator that has been around longer than the popular indicators invented and popularized by Wells Wilder in his infamous book—-New Concepts of Technical Trading. Yet its effectiveness as an indicator is a proven trading tool that has withstood the test of time. Maybe one reason ichimoku is not widely used outside of Asia much is its not an indicator that comes as a standard with charting packages. Another reason may be that not much has been written about this indicator outside of Asia so English translations have not come to the English speaking world until the last ten years or so. Many traders new to the markets within the last 20 years or so know the popular indicators invented, fine tuned  and adjusted to today’s markets.Some are not effective at all while others may have to be tweaked to a particular market while still others work but don’t have a fast response time. Not true with ichimoku since this indicator has it all, clear lines of support and resistance, clear buy and sell signals, clear entry and exits, clear in its trend capabilities and proven for its profitability. A trader doesn’t need another indicator to trade when one can understsand ichimoku. What I would like to focus on is the history of this indicator, the many uses, its misconceptions, its effectiveness and its importance for traders of all markets.
 Goichi Hosoda is the Japanese newspaperman credited with the invention of this indicator somewhere in the 1940’s. Research suggests that he worked on its perfection for many years, some say 20 years, He eventually published a book but that book was written in Japanese and didn’t have an English version until somewhere in 1968. This book is today now long forgotten and can’t be found. So others have taken up the cause and carried the semi popularity of this indicator to the English speaking world. The name ichimoku comes from the pen name Mr. Hosoda gave himself, ichimoku sanjin.The proper name for this indicator is ichimoku kinko hyo. The English translation of ichimoku simply means one look, one glance. Kinko Hyo doesn’t translate.
  By the next five lines that I will introduce, Hosoda has effectively isolated prices in the market so traders can delineate where prices are trading and make a trading decision at any point along the way.
 Tenken Sen, also called a signal line. Directly translated means convert or divert and Sen means  line. This is the first determinant of trade decisions because its the shortest, fastest moving of these moving averages.Its the conversion line. But understand that these lines cannot be used in isolation to make trade decisions. Ichimoku must be used in whole to be effective. Calculate Tenken Sen by taking the highest high of the past nine candles plus the lowest low of the last nine candles and divide by two. What we have is the first short term moving average. But this cannot be looked upon as what we know as today’s moving averages because Tenkan Sen moving averages are not based on closing prices just highs and lows. Tenkan Sen is much more effective because it eliminates false signals and false breaks that moving averages may give.
 Kijun Sen is the next moving average line. The direct translation is standard line.Why standard line? Because this is the medium term moving average and can serve as a very strong support or very strong resistance line. Its also the base line to the Tenkan line. Calculate Kijun Sen by taking the highest high of the past 26 candles plus the lowest low of the past 26 candles and divide by two.
  Next is Senkou Span A. Senkou translates to up first or first batter. Calculate Senkou Span A by taking the Tenkan  line plus the Kijun line and divide by two and offset 26 candles ahead. This ingenious line is a forward moving average with an upper boundary of support and a lower line of resistance. What we are forming here is what this indicator is known for, the cloud or the Japanese translation, the Kumo.
  The second part of the cloud is Senkou Span B. To calculate Senkou Span B, take the highest high of the past 52 candles plus the lowest low of the past 52 candles and divide by 2 and offset 26 candles ahead. Another ingenious forward moving average with a lower boundary of support and upper boundary of resistance. This completes the cloud, an area where traders should not trade if prices fall into this zone. This is one reason why Senkou Span A and B are so important parts to the whole regarding ichimoku and its uses.
 Chikou Span is the last of the moving average lines to introduce before moving into uses, characteristics, when to trade and when to go long or short using ichimoku. Chikou Span is what is known as the lagging line of ichimoku. Chiku translates to section or sector. To calculate Chikou Span, take today’s closing price plotted 26 bars back. Chikou Span serves as a market sentiment indicator used to determine momentum. Chikou Span follows price action as it serves as momentum. For example, in a short position Chikou Span will follow prices but its line will be below prices. This is where the lagging line terminology comes into use. A long position will find Chikou Span above the price.
 Notice the theme of 9, 26 and 52 throughout. These are the settings that not only come standard with the ichimoku indicator on all charting packages but its also the original settings invented, used and recommended by Mr.Hosoda through many years of solid research. Recent research reveals some try to change settings hoping for faster response times like the 7, 22 and 44 settings.The thinking is the lower the numbers on the settings, the faster response times one will experience so profits will come quicker. Those maybe taking money off the table by not using this indicator to its fullest and intended purpose. Lowering settings could lead to false signals and taking profits to early. I know this indicator well and have used it for a long time so I caution traders to use this indicator for its intended purpose and all will see huge profits no matter the markets traded. The purpose of ichimoku is to follow not just trends but solid and long lasting trends with the most solid of clear buy and sell signals. Here is how this is done.
 Senkou Span A and Senkou Span B are the two lines that delineate where the cloud is located. Between the two lines is what is known as the cloud. This is the shaded area on the charts. When prices are trading within the cloud, chances are any buy or sell signal will be weak because Senkou Span A and Senkou Span B are strong lines of support and resistance so prices will have a hard time trading outside the cloud up or down. Better wait until price can break out of the cloud and better trade signals to generate.
  Notice how some shaded areas within the cloud are huge where  Senkou Span A and Senkou Span B are lines not close together. This represents high volatility. When those lines are close together and the shaded area is small, this represents low volatility. Further regarding the cloud is when prices are trading above the cloud, this is a bullish situation and bearish when prices are trading below the cloud. Yet if Senkou Span A crosses above Senkou Span B, this is quite a bullish situation. Here just follow the cloud up on a long trend. Conversely if Senkou Span B crosses below Senkou Span A, this is a very bearish situation. Again follow the cloud until it stops and take profits. Entry should be made at the cross and exit at the next cross with a stop just above or below the actual cross. These crosses occur but not very often.
Tenkan Sen and Kijun Sen then become the most important lines to generate trade signals.
  A bullish situation occurs when the Tenkan line crosses from below the Kijun line and prices are trading above the cloud. Go long here. Entry should be made at the actual cross with a stop at the kijun line, at the first cloud line, Senkou Span A or below the cross. Exit the trade and take profits when the Tenkan line crosses below the Kijun line or when it appears that an actual cross will occur. One can also exit when the Tenkan line flattens because this may mean consolidation. After taking profits and the Tenkan  line makes a bearish cross from above the Kijun line and prices are trading above the cloud, traders could go short here at the cross with a stop above the cross. This is a very short term move. The question would have to be where to take this trade. Possibly to the first cloud line, Senkou Span A or until Tenkan Sen makes a bullish cross above the Kijun line again. Or until the Tenkan line flattens.Why to the first Senkou Span A line and the start of the cloud? Because this is a very strong line of resistance and prices won’t fall into the cloud very easily. When Tenkan Sen crosses from below Kijun Sen and prices are above the cloud, the Tenkan line should follow an upward trajectory much like any moving average line.
  A bearish situation occurs when prices are trading below the cloud and Tenkan Sen crosses from above the kijun  line. Go short at the cross with a stop above the cross. Exit the trade and take profits when Tenkan Sen crosses from below Kijun Sen or when the Tenkan line flattens. Again prices and the Tenkan line should follow a downward path just as a moving average line. Just as the above example, traders could actually go long here but its a short term move and a countertrend trade. Day traders looking for quick profits may consider this trade while swing or longer term traders would not find an interest. So for those short term day traders, stay long until the Tenkan line crosses below the Kijun line and bail out or take the trade to Senkou Span B, the bottom of the cloud if the trade will go that far. This trade is possible but not recommended.
  If the Tenkan and Kijun lines are flat or vertical no matter where prices are trading in relation to the cloud, this is a trendless market, a rangebound market where prices are going nowhere. Better to wait for the Tenkan  line to give a signal before entry. Notice how the Tenkan line is the working line where trade signals are given. This is due to the short term nature of this line. While the Kijun line is stationary, this is equilibrium and a good reason to consider placing stops at the kijun line. Its a line of resistance that is very strong, much stronger than the 9 period Tenkan line. Kijun represents a 26 period line, very strong and solid resistance. So in a bullish situation. Kijun represents a solid entry while in a bearish situation, the kijun line represents a solid short if prices should touch either one of these lines. Last of these lines is Chikou Span.
  Chikou Span is the momentum line, the sentiment aspect to the five lines. What the Chikou Span line does for a trade is give further confirmation, a reinforcement when the Tenkan line crosses. In a bullish situation where the Tenkan line makes a positive cross from below the kijun line and prices are above the cloud, we know to go long here. This is a solid trade because rarely does this indicator give false signals or false breaks. Once this formal cross occurs and Chikou Span is trading above the price, this is the strongest buy signal offered by this indicator. Its telling us that not only is this long position a good trade, but it has plenty of momentum so traders can ride this trend for a nice profit. In contrast, when the Tenkan line crosses from above the Kijun line and prices are trading below the cloud, go short. If the Chikou Span line is trading below the price, this is a strong confirmation of a good solid short position.
  Ichimoku was designed strictly for trending markets and to be used on longer term charts. The longer term charts used, the better the signal and the longer the trend will last. Trade signals change to fast on shorter term charts.Can’t filter out the false signals and noise fast enough. A recommendation would be to follow the trend on the daily chart and trade with that trend on the hourly charts when both are in sync and confirmation is given. This is good for day traders and those into trades for one day to a week. Longer term traders would find good use with ichimoku on weeklies and monthlies. Of all the indicators available to traders these days, ichimoku is one of the oldest with true time tested features and a high reliabilty factor.
 Suggested Readings  Charting with Candles and Clouds Nicole Elliott Harriman House Publishing 2007
 Brian Twomey is a currency trader and adjunct professor of Political Science at Gardner-Webb University

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