Ichimoku cloud explained
This Ichimoku indicator has been developed by Japanese traders and this is why it is better to use it with Japanese Yen currency pairs like USD/JPY, EUR/JPY, GBP/JPY etc. But sometimes this indicator also works for several other assets. The only thing a trader should remember when using Ichimoku Cloud strategy is that the nature of it is the trend indicator, so it does not show trading signals for reversal cases.
The best efficiency of the strategy is seen in strong and sustainable trend period.
Some traders would say that it would not be the best decision to use one single indicator for a whole trading strategy but they need to understand that Ichimoku Cloud is a complex of several indicators combined in one pattern and it shows several technical levels of support and resistance at the same time.
Ichimoku cloud settings
When we talk about the Ichimoku cloud settings, we should mention the need for any particular money management system. Traditionally, the default settings are the best ones because they have been placed according to developers’ research. But you could try to change settings in order to test the indicator for different trading conditions. The default settings work in the best efficient ways for H4 and daily timeframes which are suitable for mid-term and swing forex traders. Intraday timeframes like H1 and M30 have a lot of false signals in Ichimoku Cloud indicator.
The main part of the indicator is the span. You may see on the H4 chart below that it can be bullish or bearish and it determines the current trading conditions in general. Usually, the price is below the bearish span and it is above the bullish span. But there are periods when the price is inside the span and this is the uncertainty mode when the main market direction is not identified. Strong signals occur when the span is reversing from bearish to the bullish mode or vice a verse. These signals are called bearish and bullish crosses respectively.
Next key point to watch is the order in which all the three lines are placed. In a strong trend period, all the lines are placed accordingly to their periods in the settings and this order is required for the trend continuation. Moreover, the baseline and the conversion line usually indicate the nearest support or resistance levels which is very useful to determine technical ranges when it is better to add long or short positions. Any moment when the price crosses these lines is a signal that the current trend might come to an end.
How to use Ichimoku Cloud
The best way to use Ichimoku Cloud strategy is to watch the price action approaching the lines or the span. As you may see on the USD/JPY chart below, the buy signal happens when the price had a failed attempt to cross the conversion line and the only thing left from that attempt was a huge shadow on the candlestick. So the combination of candlestick patterns and Ichimoku cloud gives a strong buy signal with the take-profit level at the upper range of the span. Another example is related to bullish weakness when the price failed to break through the span’s top and the bearish pullback happened after that. In this case, a trailing take-profit could be used and a trader should watch the momentum of the price when approaching conversion lines.
If you like this strategy, you might also be interested in this: Shooting Star Candlestick
Talking about the stop-loss and take-profit orders, we should mention that everything is individual and depends on every single money management system. Although stop-losses could be set for a tight range of 40-50 pips for USD/JPY, the take-profit order could be left blank and the situation should be controlled by the trader in a manual mode then. Remember that the volatility of some other assets could be different and the stop-loss order should be changed respectively.
How to Calculate Ichimoku Cloud indicator
Ichimoku Cloud indicator has five plots.
Here you can see their names and calculations:
- TenkanSen (Conversion Line): (High + Low) / 2 default period = 9;
- KijunSen (Base Line): (High + Low) / 2 default period = 26;
- Chiku Span (Lagging Span): Price Close shifted back 26 bars;
- Senkou A (Leading Span A): (TenkanSen + KijunSen) / 2 (Senkou A is shifted forward 26 bars);
- Senkou B (Leading Span B): (High + Low) / 2 using period = 52 (Senkou B is shifted forward 26 bars).
There is no exact algorithm for the Ichimoku Cloud trading strategy since the market trends have to be analysed on a bigger scale besides the technical analysis. This strategy does not answer the question about why this particular trend happened or how long is it going to last. But it is a very effective technical tool to be used by traders who can allow themselves to trade together with the main market tendency adding more positions in the same directions if needed and also getting out of the market in the best possible moment.