Cloud Trading - Ichimoku Cloud Trading Strategy

What Is Ichimoku Cloud Trading Strategy?

The Ichimoku cloud trading strategy has been created to complete the information provided by Japanese candlesticks. The application of Ichimoku in addition to candlesticks provides a unique overview of price evolution in the past, the present and the future. Because of its versatility, Ichimoku can be seen more as a unique reading system than an indicator. Therefore, Ichimoku is a tool that frames the market by highlighting major levels from the past and the present.

When to Use the Ichimoku Strategy

The Ichimoku system is designed for markets where a trend can be easily spotted. When the market is located inside the cloud, we assume that prices have reached the equilibrium. In this case, we should refrain from using the Ichimoku system. The system is just as suitable for the investor with a longer horizon as it is for the intraday, or the short-term trader. A long-term investor will prefer a D1 frame. A daily frame will highlight key supports/resistances for the next 26 days (26 periods). An intraday trader will favour an H4 frame, which will highlight key levels of the week; a lower time frame than H1 can be used to open and close positions. A short-term trader will favour a 15-minute frame and will use the Ichimoku strategy to get the key supports/resistances for the current day.

A multiple time frame strategy could be used with Ichimoku, using the daily one for a global analysis, the H4 one to find a potential signal and to estimate risk and gain potential, and then the shorter time frame to determine the best entry on the market (lower price for a buy signal, higher price for a sell one).

What setups are we looking for in Ichimoku?

In Japanese, “Ichimoku Kinko Hyo” means “market equilibrium at a glance”. As its name suggests, Ichimoku informs the trader about the trend at a glance. If prices are located above the cloud, we assume that the market is in an uptrend. If prices are located below the cloud, we assume that the market is in a downtrend. If the price line sits within the cloud, this means that equilibrium has been reached and there are no relevant trends on the market. 

Because Ichimoku is a trend identification system, we should use it in conjunction with another indicator. Please note that if prices are located inside the cloud on a daily time frame, they could be below or above it on another time frame, so in this case, the equilibrium is reached within a daily time frame, but disequilibrium could be found in shorter time intervals.

The Components of an Ichimoku Cloud

The Ichimoku system is made up of five major lines. Two of these are synchronous with the current price, while two others represent the projection of the equilibrium of the market in the future (these two form the boundaries of the cloud). The last line is the projection of the current price plotted 26 periods in the past, and is considered to be the memory of the market.

• The Tenkan-sen (turning line) is the average of the highest price and the lowest price over the last 9 periods. The slope of the Tenkan-sen shows us the momentum of the trend.
• The Kijun-sen (standard line) is calculated in the same way, but over the last 26 periods. The Kijun serves as the last support or resistance following a break of the Tenkan by prices. In the first scenario, the Kijun acts like a support or resistance and sends prices back in the direction of the original trend, correcting an already established trend. In the second scenario, prices break the Kijun on the close. A signal is produced and we try to find the best entry.

The following two lines evolve with prices as moving averages.

• The Senkou-Span A (SSA) is the average of the Tenkan and the Kijun line, shifted 26 periods forward.
• The Senkou-Span B (SSB) is constructed in the same way as the Kijun and the Tenkan lines are, but over the last 52 periods, and shifted 26 periods forward. An important signal is when prices break the Senkou-Span B line to get out of the cloud (prices leave the equilibrium zone). The Chikou-span line, explained below, serves as a validation of this signal.

The area between the SSA and SSB is called the Cloud, which is an original aspect of the Ichimoku system. The thickness of the Cloud is the most important aspect of the Ichimoku system: a thick cloud will be more difficult to cross than a thinner one.

• The Chikou-Span (lagging span) is the price line (on close) shifted 26 periods backwards. This line will interact with the other lines of the system in the same way the prices will. It will also interact with past prices. The Chikou-Span is considered to be the market memory. The purpose of this line is to confirm the signals triggered by breaks of the Kijun or the SSB line.

How to Properly Use the Ichimoku Trading System

The Ichimoku system can be used in a single time frame as a classic indicator, as well as a reading system, by easily switching from one time frame to another. Scanning at least three time frames is a must in order to thoroughly understand a market. Thus, Ichimoku can be used in the entire workflow, from analysing the market to managing positions. The ideal and most complete reading covers three different time frames.

• A long time frame for a global analysis, identification of key levels and potential targets.
• An intermediate time frame to establish the best strategy regarding the setup by defining the Target Price, Stop-Loss and size of the position.
• A short time frame to enter the market and make sure the trade follows our scenario.

Key Takeaways

The Ichimoku system is more than just an indicator. It can be seen as a tool that frames the chart by highlighting key levels from past and current price movements. It shows “at a glance” if the market is in an equilibrium zone, or if the market is in a trend. There is no need to add other indicators, which makes readings clearer and avoids contradictory information.

The strongest signal is given by prices breaking the Kijun. Prices getting free from the cloud can also be considered a strong signal. One must wait until the close of the candle sticks to ensure there is a signal. After getting the signal, one must wait for a confirmation from the lagging span to place an order. When the lagging span gets free from all obstacles, that allows us to place an order.