Ichimoku Cloud

The Ichimoku Kinko Hyo Japanese charting technique was developed before World War II with the aim of portraying – in a snapshot – where the price was heading and when was the right time to enter or exit the market. This was all performed without the aid of any other technical analysis technique (or study).The word Ichimoku can be translated to mean “a glance” or “one look”. Kinko translates into “equilibrium” or “balance”, with respect to price and time, and Hyo is the Japanese word for “chart”. Thus, Ichimoku Kinko Hyo simply means “a glance at an equilibrium chart”, providing a panoramic view of where prices are likely to go and the position one should undertake.Invented by a Japanese journalist with a pen name of “Ichimoku Sanjin”, meaning “a glance of a mountain man”, Ichimoku charts have become a popular trading tool in Japan, not only with the equity market, but in the currency, bond, futures, commodity and options markets as well. The technique was published over 30 years ago but has only gained international attention within the last few years.

The Ichimoku chart consists of five lines. The calculation for four of these lines involves taking only the midpoints of previous highs and lows, similar to moving average studies. Yet even with this simplicity, the completed chart is able to present a clear perspective of the price action.The five lines, as shown in Figure 1, are calculated as follows:1) Tenkan-Sen = Conversion Line = (Highest High + Lowest Low) / 2, for the past 9 periods2) Kijun-Sen = Base Line = (Highest High + Lowest Low) / 2, for the past 26 periods3) Chikou Span = Lagging Span = Today’s closing price plotted 26 periods behind4) Senkou Span A = Leading Span A = (Tenkan-Sen + Kijun-Sen) / 2, plotted 26 periods ahead5) Senkou Span B = Leading Span B = (Highest High + Lowest Low) / 2, for the past 52 periods, plotted 26 periods aheadKumo = Cloud = Area between Senkou Span A and B

Ichimoku uses three key time periods for its input parameters: 9, 26, and 52. When Ichimoku was created back in the 1930s, a trading week was 6 days long. These parameters, thus, represent one and a half week, one month, and two months, respectively. Now that the trading week is 5 days, one may want to modify the parameters to 7, 22, and 44.

Most traditional technical analysis techniques are based on the open, high, low, close or average price. Others may use volatility while fixed scales such as Fibonacci numbers have also been applied. But the results are the same. Support and resistance levels are always depicted as a point or a line.With Ichimoku charts, it is the Kumo that quantifies support and resistance levels and the Kumo that can be used to project these levels into the future. It’s therefore important to note that (unlike its traditional counterparts) the support/resistance level given by the Kumo appears as a layer of varying thickness, with the thickness being related to prior market volatility.Let’s now illustrate the Ichimoku technique with an example.

Figure 2 is an Ichimoku daily chart of GBP/USD. As can be seen, the price was in a trading range for about two months between September and November 2004, trading below the Kumo which acted as a resistance level. A weak buy signal (one red up arrow) followed by a strong sell signal (three blue down arrows) and then another weak buy signal occurred during this period. After the last buy signal, the price subsequently pierced through the Kumo and an upside breakout followed.

Then in January 2005, the price retraced from its highs and traded within the Kumo for about a month without any direction. The price then surged back above the Kumo and as can be seen, the future support and resistance level from March 2005 onwards can be quantified. With Ichimoku’s theory, only when the price trades below this level can the uptrend be considered over.

Let’s now combine Ichimoku with traditional support and resistance theory: previous highs and lows will act as support and/or resistance in the future.