How to use ichimoku to read 26 bars into the future

 

A lot of traders I talk to reject the indicator I’m going to show you today, because it’s “too complicated” and makes their charts look “cluttered”. These are the same traders who put on several moving averages … a momentum indicator … and then throw in another indicator trigger …

If they’d stuck with this single ‘messy’ looking indicator, the chart would actually be much clearer and simpler. This may throw a number of lines on your chart, but it’s all under one umbrella, and it does a lot of work for you. We have trend, momentum, support and resistance all in one (slightly untidy) package.

The indicator I’m talking about is the Ichimoku cloud.

Bear with me and I’ll show you that this ‘complex’ indicator is in fact as simple to read as a moving average crossover – yet works much harder for us under the hood in terms of the technical data its crunching.

What’s an Ichimoku cloud?

Despite sounding like some ancient martial arts move, the Ichimoku cloud is a relatively modern technical analysis tool from Japan. It plots five moving average (ish) lines onto your chart. Each line has a Japanese name, which can be used whenever you want to impress someone …

Personally, I prefer to give the lines names that describe what they’re doing.

Tenkan-sen and Kijun-sen are basically two moving averages (they’re calculated from highs and lows, so are a bit fancier than your usual SMA). The Tenkan-sen is the faster moving average. The Kijun-sen is the slower moving average.

The ‘cloud’ is the area boarded by the Senkou Span A and B. These two lines are calculated from our first two moving average lines (Tenkan-sen and Kijun-sen), projected forward by 26 candles. If A is above B, we have a green (bullish) cloud. If A is below B, we have a red (bearish) cloud.

Chikou Span is a bit different. It’s the current price, but shown 26 candles behind. This takes a bit of getting used to, but is a great way of spotting if there’s any recent support or resistance levels that could get in our way.

And that’s it.

I find it helpful to think of it as two moving average crossovers, with the lagging Chikou Span indicator thrown in.

Here’s how we use it

Here are our trading rules …

• We get a signal to buy if the fast moving average (blue) crosses above the slow moving average (red). We get a signal to sell if the fast moving average (blue) crosses below the slow moving average (red).
• We will only take a buy trade is the price is above a green cloud. We will only take a sell trade if the price is below a red cloud.
• We will only take a buy trade if the Chikou Span lagging line is above the current price and in a clear space (this tells us that there are no recent resistance levels that could get in the way of our trade). We will only take a sell trade if the Chikou Span lagging line is below the current price and in clear space.
• We will close a trade when the moving averages cross back over, or if the price moves into the cloud, or the Chikou Span lagging line crosses the price.

These are the basic rules, but I know I promised you’d be able to see 26 candles into the future, so I want to show you the predictive power of the cloud …

How the Ichimoku cloud sees into the future

 Because the Chikou Span lags 26 candles behind the price, and the cloud is projected forward by 26 candles, when we look at a live chart, the Ichimoku lines look like this …

When we get a signal to buy, we look back at where the lagging indicator is. If it’s bogged down in price action, this warns us that we’re not free of support and resistance levels, so our trade could have difficulty progressing.

But the cloud that projects in front of the price action is even more useful. This is calculated from the fast and slow moving averages, and gives us a guide for where the price is heading. If the cloud is red, we can expect prices to fall. If the cloud is green, we can expect prices to rise. These twists in the cloud don’t necessarily mean that the trend is over – it can just be a consolidation.

This cloud projection has some great uses:

• a twist against the trend offers a profit-taking opportunity
• a twist in favour of the trend gives an opportunity to re-enter a market
• the edge of the cloud gives a level to use for trailing stops (the slow moving average is another, more aggressive option for stop levels).

Here’s an example of an Ichimoku trade …

Here we get a buy signal, where the fast moving average crosses above the slower moving average, and we’re above a green cloud. Remember – the lagging line will be showing 26 bars back. So, at the time of our signal, it is well clear of price action.

We can trail our trend trade, locking in profits as they build by using the slow moving average or the cloud as a trailing stop, with the cloud keeping 26 candles ahead of us.

Of course, there’s no magic in the cloud being able to predict where the price is going. (The cloud is just measured from the centre of our first two moving average lines, and a slower moving average added in – and this is just plotted 26 bars in front of us.)

But when we can’t know what’s going to be fired at us from the right-hand edge of our charts, it’s a very useful guide to what we can realistically expect coming up. Yes, price will crash into clouds some of the time, but we’ve early warning systems built into our moving average crossover and our lagging line indicator.

All in all, the Ichimoku cloud is a powerful all-in-one trading tool. I recommend you put it onto your charts and test it out. I look forward to hearing your thoughts and suggestions for getting the best out of it.

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