The Ichimoku cloud is an “all in one” indicator that was created in 1930 in Japan. At the time, forex trading had not started so why bother with this indicator?
First off, it is one of the few leading indicators out there and it is an “all in one” system so other indicators are not required.
Moreover, its components provide information about support/ resistance levels, trend direction, and momentum all at the same time.
It is a very good indicator for beginners. It instills discipline and trend trading. Some money management practices are built into this indicator.
The Ichimoku indicator is a potent trading tool. However, it is quite complicated to use at first glance and charts tend to look messy.
Fret not, I’ll give a gradual breakdown of the Ichimoku cloud in this piece.
Although, the Ichimoku can feel really strict, and sometimes, good trades will be missed.
To go about this, trades can be taken with half of the intended risk if some of the components of the indicator line up.
Components of the Ichimoku Cloud
The Ichimoku cloud is made up of four components. Each will be broken down and explained below;
Senkou Span A and Senkou Span B
These spans are the component of the Ichimoku that indicate trend direction.
- Senkou Span A: the sum of the Tenkan Sen and the Kijun Sen divided by two. The calculation is then plotted 26 time periods ahead of the current price action.
- Senkou Span B: the sum of the highest high and the lowest low divided by two. This calculation is taken over the past 52 time periods and is plotted 26 periods ahead.
Once plotted on a chart both of these spans form a cloud as seen in the image above.
Basically, it filters out high probable trades by keeping you in line with the current market trend.
The overall trend is up when the price is above the cloud, down when it is below and consolidating when the price is in the cloud.
Furthermore, when Span A is rising and above Span B, it confirms the uptrend, and the space between the lines is green.
On the other hand, when Span A is falling and below Span B, this confirms the down-trending. The space between the lines is colored red in this case.
Rules of the Senkou Span
- Only buy positions are taken when the currency pair is trading above the clouds.
- Sell positions are taken when the currency pair is trading below the clouds.
- Trades are not allowed when price is inside the cloud.
Tenkan-sen and Kinjun-sen
The component for determining trend has been determined but how do you enter positions?
The tenkan sen and the kinjun sen indicate entry opportunities.
The tenkan sen and the kinjun sen work just like a moving average but they do not move as smoothly as it does.
Tenkan acts like the fast-moving average in this system while the kinjun sen reacts slower to price action.
Both of these are used for entries whenever they cross. This system is the same as the moving averages crossover.
To use these for entries, the crossover is used to initiate a position similar to a moving average crossover.
Put simply, they act as dynamic support and resistance levels.
Entry Rules
- When the tenkan crosses the kijun upwards, you go long.
- When the tenkan crosses then kijun downwards, you go short.
Note: buy orders are only placed if the price is above the cloud while sells are placed if the price is below the cloud.
Chikou Span
The final component in this system is used to gauge the market’s momentum.
This is a rarely used component of this indicator. If a point is plotted 26 candles behind closing prices for previous sessions, the chikou span will be formed. This calculation is automatically done by trading software.
The chikou span feature suggests the market’s sentiment by showing the prevailing trend as it relates to the current price momentum.
How To Trade With The Ichimoku Cloud Indicator
Every component of the Ichimoku cloud works in harmony to forecast future pricing. A glimpse of this indicator’s strengths and weaknesses will be shown by backtesting the daily chart of GBPUSD.
Scenario 1
In this first example, the tenkan-sen crossed the kinjun-sen downwards indicating a sell signal.
The cross occurred above the cloud which invalidates the sell signal. But, the signal was a valid one.
This is a frequent occurrence with the Ichimoku cloud. As mentioned earlier, the sell can be taken with minimal risk.
Scenario 2
As seen above, the price is trading below the cloud. This indicates that the market is down trending.
An order will be placed when the tenkan and kinjun crosses.
If we had used the chikou span in the two examples above:
In a bullish scenario, it is ensured that the chikou span is above the cloud as well.
While in a bearish scenario it has to be below the cloud.
If the ichimoku span happens to be in the cloud or on the wrong side of the cloud, the trade is ignored.
Exit condition of the Ichimoku cloud
Positions will be left open until the price closes the other way across the tenkan-sen baseline. Immediately it crosses, profit should be taken.
Also, momentum indicators can be used to determine when a trend is coming to an end.
The Ichimoku cloud enables you to ride along with market trends. The end of these trends can be predicted when the price crosses the tenkan.
For further confirmation, a momentum indicator like the RSI or Stochastic Oscillator can be used.
Both of these indicators track the strength of trends and it is displayed as overbought and oversold regions.
The Ichimoku cloud is a very accurate indicator because of the strict set of rules that guide entries.
The Ichimoku cloud is a very versatile indicator and can be used on a variation of time frames.
But, the true potential of this indicator can only be realized by swing trading.
The daily or 4-hour time frames are recommended. Although, this means only a few volumes of valid trades will be gotten.
Summary; The Ichimoku Cloud- How to Use It in Forex Trading
All things considered, the Ichimoku cloud is overall a very good indicator; especially for beginners.
It helps to prevent over-trading and improves money management. These virtues are very important to be successful in the forex market.
Furthermore, it is one of the few indicators out there that shows market trends and gives entries to buttress.
However, a lot of trades with good potential are missed which is not ideal.
In brief, the cloud indicates the market’s overall trend and guides our decision.
Further, the tenken and kinjun give you a platform to trade these recognized trends.
Lastly, the chikou span acts as insurance to validate the market’s momentum.
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