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The Ichimoku Cloud Forex Trading Strategy

The Ichimoku Cloud Is More Of An Advanced Trading Strategy Compared To The Likes Of Swing Or Scalping.

Developed in the 1960’s in Japan by Goichi Hosada, the Ichimoku cloud (AKA Ichimoku Kinko Hyo) was first released in a publication of 4 books which contained over 1000 pages.

Following the release of the Ichimoku cloud, Goichi Hosada changed his name to Ichimoku Sanjin. This Forex trading strategy was originally created for the Japanese stock markets, this cloud indicator began to make its way into the western trading world through the stock, commodities, and forex markets.

The goal of the Ichimoku cloud is to provide the trader with a comprehensive idea of each market at a single glance.

 To rephrase, the Ichimoku cloud is designed to provide information regarding trend, momentum, price action, key support and resistance levels, including potential pivot points and possible future direction. 

We will cover the core elements of the Ichimoku cloud, including the 5 lines and the 3 pillars.

The 5 Lines of Ichimoku

This is what Ichimoku is known for predominantly – The infamous 5 lines that are unique to Ichimoku.

 

The Ichimoku cloud indicator A

The 5 lines of the Ichimoku cloud are:

  • The Tenkan-sen (sen means ‘line’ in Japanese)
  • The Kijun-sen
  • The Chikou Span
  • The Kumo (or cloud, which is composed of the Senkou Span A & B)

The clearest aspects of Ichimoku are shown in the 5 lines above and provide a lot of information regarding an instrument’s price action – let’s Here we discuss the 5 lines and what they

represent for the investor or trader.

The Tenkan-sen

The Tenkan-sen in the above chart is similar to a 9 EMA (exponential moving average), acting as dynamic support or resistance, however uses a slightly different calculation.

The Tenkan-sen can be calculated by taking the highest high + the lowest low over the last 9 periods (or candles if you will) to create a line describing those 9 periods of price action.

The most appropriate method to imagine the Tenkan-sen is as a line that calculates momentum and volatility.

It incorporates both short and medium-term momentum (by covering the last 9 periods) but also includes volatility which is represented in part by the highest highs and lowest lows over that same 9-period.

In general, when the Tenkan-sen is in an up-trend and the price action is above the Tenkan-sen, the market is considered to be strongly bullish.

 

For downtrends, however, if the price action is seen below the Tenkan-sen in a down-trend, then the market is strongly bearish.

The Kijun Sen

 The Kijun-sen is mainly referred to as the trend line (datum line), which means its function is to analyze the overall trend of the stock, instrument or pair.

when the Kijun-sen is trending upwards and the price action is above, the market is in a bullish trend, and so goes it the means are reversed – if it’s trending down while the price action is below it, the market is in a bearish trend.

The Kijun-sen represents the highest high + the lowest low over the last 26 period, so the same calculation as the Tenkan-sen applies, but over a longer period, so to capture the overall trend, but it is not as sensitive to short-term waves of volatility and/or momentum.

The Ichimoku cloud indicator C

The Chikou Span

 The Chikou span is a lagging line that takes the current closing price and shifts it back 26 periods (or candles).

You might ask why would the Chikou span is shifted back 26 periods?

The thought is to take the current closing price and compare it to the prior price action to notice if there is future resistance in a bullish trend or support lower in a bearish trend.

If the Chikou span is above the previous price action, then there is little history or resistance in the way of that particular trend (for a bullish trend or bearish trend). 

In the chart below, we can see the Chikou span (purple line) has no price action or structures above it, which shows no historical resistance in the way.

The Kumo (or cloud)

The most unique aspects of the Ichimoku cloud is the Kumo (cloud) section of the indicator.

If you notice in the chart below, the cloud is both below and ahead of the current price action.

 This is because Span A (the upper part of the cloud in a rising cloud) is formed by taking the Tenkan-sen and adding it to the Kijun-sen, now dividing that same value by 2, then marking it 26 periods ahead. Which gives you: – (Tenkan Line + Kijun Line) / 2 placed 26 periods ahead.

Span B is formed by taking the highest high (over the last 52 periods) and adding it to the lowest low (over last 52 periods), divide by 2 and plotting it 26 periods ahead. Which gives you: – (Highest High + Lowest Low over last 52 periods) / 2 and plotted 26 periods ahead.

The Ichimoku cloud indicator E

The main objective of the Kumo is to give the trader an insight of future support and resistance.

I summary 

if the price action is above the Kumo while its rising, you are in a bullish trend. If the price action is below the Kumo while its falling, you are in a bearish trend.

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You will notice across many forex charts (especially higher time frames like the 4hr, daily and weekly charts) that strong bullish trends stay above the Kumo for long periods of time. They sometimes pull back to the Kumo, treat it as support, and then continue in the bullish trend.

This is used for potential market entry points for forex traders to add positions, or for swing traders looking for potential pullback opportunities to go long.

 5 Lines Closing Comments

The 5 lines of Ichimoku have both individual functions and provide a overall glance of the market’s current trend (Kijun), momentum (Tenkan), along with potential future support or resistance levels (Kumo). 

There are more advanced aspects of the Ichimoku cloud namely the 3 Ichimoku pillars. We move onto the more advanced aspects of the Ichimoku cloud.

The 3 Pillars of Ichimoku

Whilst most traders associate Ichimoku with its 5 lines, the core base of Ichimoku theory is the 3 pillars. Below are the 3 pillars which all of Ichimoku is based upon:

  • Ichimoku number theory
  • Ichimoku wave theory
  • Ichimoku time theory

 Ichimoku number theory is based upon years of research by Goichi Hosada who studied many Eastern and Western theories, including physics, Fibonacci and various numerological systems.

 Eventually, he settled upon 3 numbers that became the core aspect of all Ichimoku numbers. They were 9, 17 and 26. technically there are10 numbers in all, however these are the primary ones.

According to the original texts, these numbers are referred to as one section (9), two sections (17) and 1 period (26).

We invite you to spend time studying Ichimoku number theory, however it may not have many practical applications for the everyday trader.

The second pillar of the Ichimoku cloud is referred to as Ichimoku wave theory.  This pillar has multiple applications for almost every style of trader.

In Ichimoku wave theory, it references 3 main types of waves, these are action structures that produce more probable directions for future market moves. 

The three waves are I waves (1 leg), V waves (2 legs) and N waves (3 legs).

Ichimoku Cloud Trading 1

You will notice that all 3 types of core waves can be upward or downward in direction. 

You will most likely see that the I waves are impulsive moves, the V waves are two impulsive moves in opposite directions, and the N waves are impulsive moves, followed by a corrective move, followed by continuation with yet another impulsive move in the same direction.

I waves (or impulsive moves) signal a prominent fluctuation in the order flow to single side of the market. When there is an imbalance in the order flow to either buy or sell side, the market moves directionally. The stronger the imbalance, the stronger the directional move.

Between the 3 waves, the N wave and V wave are mostly suggestive. 

This is because a V wave is an impulsive move followed by a counter-directional impulsive move. This likely confirms a strong amount of buying (or selling) was met with a counterforce of buying (or selling) confirming a strong rejection at the top (or bottom of the V wave).

On the other hand, the N wave shows a dominant I wave, followed then by a corrective pullback, followed again by a trend continuation of the first impulsive move.

This depicts the direction will likely continue until you see a disruption in this wave structure, subtlety via a counter-trend I wave (impulsive move).

Then there are more complex wave structures such as P waves and Y waves, which are simply described as expanding and contracting volatility waves, but the core aspects of wave structure remain in these 3 waves.

The third pillar of Ichimoku is price-theory. The main objective of Ichimoku price theory is to give ‘possible’ future targets of specific moves based upon their price action structure and depth of the move. 

All price calculations essentially make up the different types of N waves with varying degrees of pullbacks and retracements before the next anticipated leg will develop or continue.

The three main price calculations are:

  • The V calculation = B + (B – C)
  • The N calculation = C + (B – A)
  • The E calculation = B + (B – A)

 The formulas listed above have corresponding structures and graphs that you can see below.

 

The calculations above all have 4 legs in the move (A, B, C and D). Ichimoku price theory explains that based upon the calculation and type of move, D will be the probable target for the move from C.

You can see from all 3 types, they are all essentially various forms of N waves. The deepest pullback is the V calculation (C), the N calculation has the least (corrective) pullback, whilst the E calculation has onnly a mild pullback, however deeper still than the N calculation.

The most appropriate method to use these calculations is to discover the one that most describes the current 3-legged structure you are trading in, and when you see the price bouncing from the C point, use your specific calculation to anticipate a potential target for the next move up.

Those are the three main Ichimoku pillars, however, very few Ichimoku traders will ever fully understand each of them, mostly due to the original texts being in Japanese and having not yet been completely translated into English.

In Closing

For long-term sophisticated investors or forex swing traders, the Ichimoku cloud can be an in-valuable Forex technical analysis tool to assist you in your decision to potentially add market entries

and determine the overall trend, momentum and future support and resistance