Ichimoku Cloud - Technical Indicator Explained

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Goichi Hosoda, a Japanese journalist, created the Ichimoku Kinko Hyo charting technique, which translates to “equilibrium at a glance chart.” He intended to create a system that would allow a trader to quickly and readily appraise trend, momentum, and support and resistance levels. He began working on the system before World War II, and it was published in 1968, after more than two decades of testing.

Ichimoku Cloud is now deployed in algo-trading software to empower traders with one-touch solutions.

What is Ichimoku Cloud?

The Ichimoku Kinko Hyo is a technical indicator used to measure momentum together with potential areas of support and resistance. The tenkan-sen, kijun-sen, senkou span A, senkou span B, and chikou span are the five lines that make up the all-in-one technical indicator.

Ichimoku could appear highly confusing for inexperienced traders, but the complexity quickly evaporates in order to comprehend what the different lines indicate and why they are utilized.

Despite its objective of being an all-in-one indication, the Ichimoku indicator is employed best in conjunction with other forms of technical analysis.

Components of the Ichimoku Cloud

The Ichimoku indicator has five major components:

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Tenkan-sen: The tenkan-sen, or conversion line, is computed by adding the highest high and highest low from the previous nine periods by two. The resulting line serves as a critical level of support and resistance, as well as a reversal signal line.

Tenkan-Sen = (9-Period Highest High + 9-Period Lowest Low) / 2

Kijun-sen: The kijun-sen, or baseline, is computed by adding the highest high and lowest low during the previous 26 periods by two. The resultant line can be utilized as a trailing stop-loss point and serves as a critical support and resistance level, as well as a confirmation of a trend change.

Kijun-Sen= (26-Period High + 26-Period Low) / 2

Senkou Span A: The senkou span A, also known as the leading span A, is determined by adding the tenkan-sen and kijun-sen, dividing the result by two, and charting the result 26 periods ahead. The resulting line produces one of the Kumo — or (cloud) which are utilized to define future regions of support and resistance.

Senkou Span A = (Tenkan-Sen + Kijun Sen) / 2

Senkou Span B: The senkou span B, also known as the leading span B, is computed by adding the highest high and lowest low from the previous 52 periods, dividing by two, and charting the result 26 times forward. The resulting line is used to identify future regions of support and resistance on the other side of the Kumo.

Senkou Span B = (52-Period High+ 52-Period Low) / 2

Chikou Span: The chikou span commonly known as the lagging span, is the current period’s closing price plotted on the chart 26 days ago. This line is used to depict areas of potential support and resistance. A buy signal is displayed when the Chikou span crosses the price from the bottom up. If, on the other hand, the line crosses the price from the top down, it is a sell signal.

How to compute the Ichimoku Cloud?

The highs and lows indicate the highest and lowest prices seen throughout the time, for example, the highest and lowest prices seen during the last nine days in the case of the conversion line. Adding the Ichimoku Cloud indication to your chart will handle the calculations for you, but if you prefer to do it manually, here are the steps:

  • Compute a Conversion Line and a Base Line.
  • Based on the previous calculations, compute Leading Span A. This data point is then generated and plotted 26 periods in the future.
  • Determine Leading Span B. Plot this data point 26 periods in advance.
  • Plot the closing price 26 periods in the past on the chart for the Lagging Span.
  • To construct the cloud, the difference between Leading Span A and Leading Span B is colored in.
  • Color the cloud green when Leading Span A is higher than Leading Span B. When Leading Span A is lower than Leading Span B, color the cloud red.
  • The preceding steps will result in the creation of one data point. To make the lines, once each period ends, repeat the steps to create fresh data points for that time. To create the lines and cloud appearance, connect the data points together.

What Does the Ichimoku Cloud Indicate?

When the price is above the cloud, the general trend is up; when the price is below the cloud, the trend is down; and when the price is in the cloud, the trend is trendless or transitioning.

When Leading Span A rises and crosses over Leading Span B, the uptrend is confirmed, and the area between the lines is often colored green. When Leading Span A falls and falls below Leading Span B, it confirms the downtrend. In this situation, the gap between the lines is often colored red.

Traders will frequently use the Ichimoku Cloud as a level of support and resistance based on the price’s relative position. The cloud offers support and resistance levels that can be projected into the future. This distinguishes the Ichimoku Cloud from other technical indicators, which only show support and resistance levels for the present date and time.

Traders should employ the Ichimoku Cloud in conjunction with other technical indicators to maximize risk-adjusted returns.

What is the limitation of using Ichimoku Cloud?

With all of the lines, the indicator can make a chart appear cluttered. To address this, most charting software allows you to hide specific lines. For instance, all lines except Leading Span A and Leading Span B, which form the cloud, can be hidden. Each trader should concentrate on whatever lines provide the greatest information, then consider hiding the rest if they are all distracting.

The Ichimoku Cloud also has the problem of being based on past data. While two of these data points are projected in the future, the algorithm is not intrinsically predictive. Averages are simply projected into the future.

The cloud can also become meaningless for extended periods of time if the price remains far above or below it. In these circumstances, the conversion line, the baseline, and their crossovers become more relevant because they are generally closer to the price.

Disclaimer: There are potential risks relating to trading and investing and you should not trade with money that you cannot afford to lose however, for those that educate themselves and adopt appropriate risk management strategies, the potential update can be significant. Please note that all opinions, research, analysis, and other information are provided as general market commentary and not as specific investment advice.

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