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Trading with Ichimoku

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Trading with Ichimoku

What is the ichimoku indicator?

The Ichimoku Strategy is an abbreviation of the Ichimoku Kinko Hyo, which was developed by a Japanese journalist named Goichi Hosoda in the 1960s after 30 years of working within this indicator. This technique has been popular in Japan for quite some time now and it has gained popularity in other parts of the world as well. Ichimoku Kinko Hyo means “instant look at the balance chart” if you literally from Japanese. It is based on other charting indicators like candlesticks and moving averages so it is considered a technical strategy. Basically, the Ichimoku indicator is a group of indicators or a strategy that indicates the trend. It uses multiple point moving averages that are calculated based on the medium price of the candlesticks or (high+low)/2.

There are six components that make up this indicator:
Tenkan sen (red line) –
It is calculated as the middle price for the last 9 candlestick highs-lows. This is an important line of Ichimoku because it is an early indicator of the trend; there´s no trend when this line is horizontal but once it takes a direction it´s very likely that a trend has begun.
Kijun sen (blue line) – This line follows the last 26 candlesticks. Therefore, it is slower than the red line so it moves with a time lag. The blue line is used as an indicator of trends.
Senoku span A (green interrupted edge of the cloud) – This forms one of the edges of the Kuomo cloud and is the fastest moving one, seen here crossing over the other; thus shifting the cloud at its squeezing point. It is calculated as a sum of the two sen lines, divided by two and then plotted 26 periods in advance.
There are 6 components within the Ichimoku indicator.
Senoku span B (red interrupted edge of the cloud) – This line is the lower edge of the cloud and it is calculated as the average of the high/low of the last 562 candlesticks.  It is plotted 26 periods in advance as well, and that’s the reason the cloud stretches farther ahead of the last price candlestick.
Kuomo cloud (the gridded area) – This is the space between the two Senoku span lines and it is called theKuomo cloud. This cloud changes shape; when the market trades in a horizontal range the cloud is thinner, and when the market is trendy the cloud widens, so the stronger the trend the greater the cloud width.
Chickou span (wrinkled green line) – This is a lagging indicator because it is calculated by projecting 26 days from the today´s closing price. This line indicates a trend in the same direction that crosses over the price occurs, that´s why it is called the momentum line.

On the chart below there´s another, straighter green line which comes up automatically on the MT4 platform when you add the Ichimoku indicator. While it is not considered a true indicator, it can be very useful to couple it with the Ichimoku and form a sound trading strategy, and we’ll elaborate on this below.

The figure below is the EUR/AUD weekly chart where we see the Ichimoku indicator.

 There are 6 components within the ichimoku indicator.
There are 6 components within the ichimoku indicator.

Applying the Ichimoku indicator in everyday trading

As we explained above, there are many smaller indicators within the more complex Ichimoku indicator, and these are more than enough to build several trading strategies, either individually or in combination. Since the Ichimoku is a trend indicator you should know that it is most effective in trending markets. It can be used in all timeframe charts as well. Let´s start by explaining the strategies that the components offer a trader, starting with the leading indicators.

The tenkan sen and the kijun sen are both moving averages, and one of the most popular strategies offered by normal moving averages is the cross over. So this is the primary trading strategy of these two lines and the most leading indicator. As we can see on the USD/JPY chart above the black dots, the first signal of a possible trend reversal is when the tankan sen(trigger line) crosses over the kijun sen (base line). This signal alone is enough for the most daring traders to open a buy position. But I prefer to get further confirmation before jumping in feet first.

The main component of the Ichimoku indicator is the cloud. As we said above, the cloud widens when the trend strengthens and minimizes when there is a weak trend. It also changes colours; it´s red when the price is in a downtrend and the cloud shifts like a ribbon, becoming green when the price is up. These are the default settingsbut you can always change them. The main purpose of the cloud it to indicate the trend; if the price is above the cloud then we are in an uptrend and vice versa. So the ultimate confirmation that this indicator offers is the price crossover of the cloud.

 The two MA crossovers are buy signals.
The two MA crossovers are buy signals.

But I still hesitate to enter a trade immediately after the price breaks above the cloud. Instead, I prefer to sit on the sidelines and wait until the price retraces back down. This way I can define the risk better and minimize it by placing the stop loss below the lower line of the cloud. After getting in, you can ride the uptrend as long as the price remains above the cloud and the cloud is green. I usually add to the position on the retraces to the tenkanand the kijun lines and trace the original stop below these two lines. The crossover strategy of these two lines can be applied before the price moves above the cloud, but the safest way is to use this strategy after the price has crossed the cloud, as you can see on the chart above the second black mark.

Last but not least is the Chickou span line which is a momentum indicator. Adding this line to the trading strategy might seem a little complicated but it´s actually quite simple. It indicates the momentum of the price and since it is a lagging indicator it acts as trade confirmation. The Japanese traders that use ichimoku as their primary indicator/strategy consider this as the main component. They use it as a confirmation after the price has moved above the cloud and the crossover of the tenkan and the kijun lines has occurred. This strategy is for the more conservative traders and requires patience as it lags price action. It is most effective on the longer period time-frames, because you can get whipsawed if you use it on the smaller time-frame charts. You can also add extra indicators to the chart, such as longer period moving averages and a Stochastic. You can combine them with the Ichimoku indicator for an added probability of success.

The Ichimoku indicator has 5-6 smaller indicators built within, which can be used to form several trading strategies. With so many indicators you have several signals, starting from leading signals to lagging, so you have multiple chances to enter a trade. The Ichimoku can be used by the impulsive traders who jump in after their leading signal, as well as those traders who are more reserved and prefer to have more than one confirmation in order to enter a trade.

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