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How to Use Ichimoku Cloud to Identify Trading Opportunities

The Ichimoku Cloud strategy uses several datapoints to indicate the direction and momentum of the markets and is used for identifying support and resistance levels.

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

 

At first glance, the Ichimoku Cloud appears to be far more complicated than the indicators you may have mastered so far. This indicator packs in a lot of information and presents it visually in a very effective way. Created by Japanese journalist Goichi Hosoda in the late 1960s, this one-in-all indicator is used to determine the trend, momentum and volatility in the market as well as support, resistance, and potential reversals.

 

1. Things to Know About the Ichimoku Cloud

Here’s a quick introduction to the Ichimoku Cloud, before deep diving into the strategy.

  • The Ichimoku Cloud makes use of moving averages to determine the trend and momentum. This lagging indicator can be used in any timeframe. If you’re an intraday trader, you may use charts of a few hours, while long-term traders typically use daily or weekly charts.
  • It uses five indicators corresponding to different timeframes. Most popularly, the 9-day moving average, 26-day moving average, an average of the first two MAs, a 52-day average, and a lagging closing price line.
  • The trend is positive when prices are above the Cloud and negative when prices fall below. When prices remain within the Cloud, the trend is said to be flat.
  • This is a highly flexible indicator that can be used for trading equities, forex, commodities, cryptos and CFDs.

2. How to Use the Ichimoku Cloud Strategy?

The Cloud comprises of five lines that provide important information about price movements and trends. Here’s a detailed look at them.

A. Tenkan-Sen or the Conversion Line

Represented by a red line on the chart, Tenkan-Sen is the first component of the Ichimoku Cloud. It is a moving average of the highest high and lowest low of the last nine periods.

Strategy Tip

A horizontal line indicates a ranging market, while an upward or downward moving line shows a trending market.

B. Kijun-Sen or the Base Line

Represented by a blue line, Kijun-Sen is formed by taking the average of the highs and lows of the last 26 periods. This line generally lags the Tenkan-Sen.

Strategy Tip

The asset’s price rising above the Kijun Sen, while the blue line is above the Cloud, is considered a buy signal. Similarly, a sell signal is generated by the asset’s price falling below the Kijun Sen when it is below the Cloud.

C. Senkou Span A (Average of the Conversion and Base Lines)

This line is the average of the highs and lows of the Tenkan-Sen and Kijun-Sen and is plotted for 26 periods to the right. The Senkou Span A is represented by an orange line and is important to identify support and resistance levels.

Strategy Tip

If the asset’s price is above this orange line, the Tenkan-Sen and Kijun-Sen become the first and second support levels, respectively. When the price is below the orange line, the Tenkan-Sen and Kijun-Sen become the second and first resistance levels, respectively.

D. Senkou Span B

This represents the average of the highs and lows of the past 52 periods and is plotted 26 points to the right.

Strategy Tip

When the Spans A and B switch positions, it is considered a sign of an impending trend reversal.

E. Chikou Span

Represented by a green line, this line is formed by taking the current price of the asset and shifting it back 26 periods to the left. The Chikou Span is a lagging indicator that hovers below the price when the market is dominated by sellers and stays above the price when the bulls are dominant.

Strategy Tip

If the Chikou Span crosses the price from the bottom, it is a buy signal, while if it crosses the price from above, it is a sell signal.

3. Understanding the Ichimoku Cloud

The area between the Senkou Span A and B forms the shape of a cloud and is called the Kumo. This cloud is comparatively thicker than the regular support and resistance lines and takes into consideration the volatility of the markets. Observing the location of the price in comparison to the cloud helps identify the trend. If the price is within the cloud, the market is considered flat. If the price is above or below the cloud, the market is in an uptrend or downtrend, respectively.

A green cloud appears when the Senkou Span A is rising and is above the Senkou Span B line. A downtrend is reinforced when the Senkou Span A is falling and is below the Senkou Span B line. This is depicted by a red cloud.

Strategy Tip

The cloud’s angle tells you the strength of the trend. When the cloud is rising at a steep angle, it indicates a strong bullish trend. Similarly, when the cloud is falling at a steep angle, it is indicative of a strong bearish trend. Experienced traders typically avoid trading when the price is within the cloud.

4. Identifying Bullish and Bearish Trends

To confirm a bullish trend, the following criteria should be met:

  • The price should be above the Tenkan Sen.
  • The Tenkan Sen should be above the Kijun Sen.
  • Both Tenkan Sen and Kijun Sen should be rising, along with the price.
  • The Kijun Sen should not be too far from the price.
  • The cloud (Kumo) created should be green.
  • The price should be above the Kumo.

To confirm a bearish trend, the following criteria needs to be met:

  • The price should be below the Tenkan Sen
  • The Tenkan Sen should be below the Kijun Sen.
  • Both Tenkan Sen and Kijun Sen need to be falling, along with the price.
  • The Kijun Sen should not be too far from the price.
  • The Kumo created should be red.
  • The price should be below the Kumo.

The Ichimoku Cloud indicator is often used with RSI (Relative Strength Index) to confirm the momentum in a specific direction.

Key Takeaways

  • The Ichimoku Cloud indicator comprises of five components, the Tenkan Sen, Kijun Sen, Senkou Span A, Senkou Span B, and Chikou Span.
  • When prices are above the Tenkan Sen, the trend is said to be bullish. When prices are below this line, the trend is bearish.
  • If Tenkan Sen and asset prices are above the Kijun Sen, it indicates an uptrend. A downtrend is indicated by the Tenkan Sen and asset prices lying below the Kijun Sen.
  • Senkou A lying above Senkou B produces a bullish Kumo and below creates a bearish Kumo.
  • Since Senkou A and B are constructed 26 days ahead of the most recent price action, they help determine support and resistance levels.
  • When prices change, the Kumo’s height changes, affecting the support and resistance levels.
  • The height of the cloud signifies the extent of volatility in the market. Narrow clouds suggest weak support and resistance levels, while these levels are stronger with clouds formed by steeper lines.
  • The Chikou Span crossing the asset price from the bottom represents a buy signal, and from above generates a sell signal.

 

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