Theory, Structure, and Strategy
What is Ichimoku Cloud?
Ichimoku Cloud Theory, also known as Ichimoku Kinko Hyo, is designed to provide the technical analyst an understanding of the movement of the financial markets in ‘one glance.’ Goichi Hosoda (1898–1982), a Japanese financial journalist, researched, tested, and developed the Ichimoku Cloud indicator. In 1968 he published all his research, describing and naming the indicator, Ichimoku Kinko Hyo. The translation of Ichimoku Kinko Hyo, aptly describes its purpose: “one glance equilibrium chart.”
The Ichimoku Cloud chart is easy to read and indicates if the market is in balance. An analyst can evaluate an Ichimoku Cloud chart and quickly determine the trend.
Basic Principle of the Ichimoku Cloud Indicator
The Ichimoku Cloud Indicator is composed of 5 lines which are drawn using mid-price points and current price. The mid-price points are simply an average price of the highs and lows of the bars in the period. Two moving average lines, the Tenkan Sen and the Kijun Sen, are calculated based on mid-price points. These two lines display price momentum and short and medium-term support/resistance reference points of the market.
The two Ichimoku Cloud lines, the Senkou Span A and the Senkou Span B, are calculated using the current price along with the Tenkan Sen and the Kijun Sen lines. The Span A and Span B lines are shifted into the future and the cloud is the area created between them. If the Span A is above the Span B, the cloud is considered bullish. If Span B is above Span A the cloud is bearish. The cloud lines represent longer-term support/resistance levels in the market. When price falls inside the cloud the market is in equilibrium representing non-trending uncertainty.
The fifth line, the Chikou Span, is today’s price plotted behind in time. This line acts as the market’s memory and the Chikou Span will react to support and resistance points of the past, giving a green light or red light to allow the current price to move freely.
The position of the current price in relation to the 5 Ichimoku Cloud lines gives traders the necessary knowledge to anticipate future price action.
Construction of the Five Line of Ichimoku Cloud
a. Tenkan-sen (Conversion Line)
The Conversion Line is the mid-point of the highest high and the lowest low of the last 9 periods.
(Highest High + Lowest Low)/2, of last 9 periods
b. Kijun-sen (Base Line)
The Base Line is the mid-point of the highest high and the lowest low of the last 26 periods.
(Highest High + Lowest Low)/2, of last 26 periods
c. Senkou Span A (Span A)
The Span A is an average of the Tenkan-sen and the Kijun-sen, of the last 26 periods, which is then plotted 26 periods into the future.
(Tenkan-Sen + Kijun-Sen)/2, of last 26 periods, plotted 26 periods ahead
d. Senkou Span B (Span B)
The Span B is the mid-point of the highest high and the lowest low over the last 26 periods, which is plotted 26 periods into the future.
(Highest High + Lowest Low)/2, of last 26 periods, plotted 26 periods ahead
e. Chikou Span (Lagging Line)
The lagging line is the current closing price plotted 26 periods in the past.
The Three Theories of Ichimoku Cloud
The 5 lines of the Ichimoku Cloud Indicator are only the first step of understanding Ichimoku Cloud analysis. The Ichimoku Cloud theory, as designed by its creator, Goichi Hosoda, is a complete trading methodology. The complete Ichimoku Cloud theory is composed of three principles.
- Ichimoku Cloud Waves
- Ichimoku Cloud Price Targets
- Ichimoku Cloud Timing Numbers
These principles work together to give the trader entry signals, price targets, and time structure to know when the market will turn.
Ichimoku Cloud Waves
Ichimoku Cloud Waves are an essential component to successfully trading with Ichimoku Cloud. The waves show the price action of the market. With the 3 basic wave formations, intermediate highs and lows become easily visible on the chart. Ichimoku Cloud waves are labeled sequential numerically (or alphabetically) with no limit to the number of consecutive waves.
3 Basic Waves Formations
1. I Wave
2. V Wave
3. N Wave
The I Wave is the market going up or down in a straight line. It is often considered an impulsive leg of a move.
The V Wave is formed from an I Wave in one direction followed by an I Wave in the opposite direction. Together, they form a V pattern, often discussed as an impulsive leg followed by a corrective leg.
The N Wave is formed from three consecutive I Waves that move prices up or down. The I Waves form an N pattern which results in either a higher high or lower low than from the price’s starting point. The N wave is typically composed of an impulsive leg, then a corrective leg, followed by an impulsive leg in the same direction as the initial leg.
Ichimoku Cloud waves show areas of support and resistance. The analyst can now use the wave formations to determine accurate points of entry. Additionally, wave formations give the analyst price targets and timing points for price turns in the market.
Ichimoku Cloud Price Targets
Ichimoku Cloud price targets are a critical component to seeing in advance where the market will stop or pause. Price targets give the trader a key component to knowing where to take profits for trading success.
Price targets are determined from the Ichimoku Cloud waves. By taking measurements of the wave legs within the pattern, targets are determined. The four main bull price targets of Ichimoku are formulated as follows:
1. The V formula = B + (B – C)
2. The N formula = C + (B – A)
3. The E formula = B + (B – A)
4. The NT formula = C + (C – A)
To better understand the price target patterns here are diagrams of the waves labeled with A-B-C.
These formulations are for bull price targets. Bear price targets would use subtraction rather than addition to find the target. For example, the bear target V formula = B -(B-C).
When calculating price targets it is important to first determine your waves. Price targets are determined from wave measurements, so you have to first label the waves of the move before finding the correct price target formula.
Ichimoku Cloud Timing Numbers
The Ichimoku Cloud Timing Numbers are based on three numbers: 9, 17 and 26. Goichi Hosoda, the developer of Ichimoku Cloud, spent years evaluating and testing to determine these specific numbers. You’ll note these numbers are used in calculating the Ichimoku Cloud lines. These basic numbers are further combined as building blocks to determine (approximate) times the market will have a turning point or a reaction at these points. The compound numbers calculated from the first three are as follows:
65 ( 33+33-1)
To avoid double-counting you’ll note the calculations include the removal of 1, 2, or 3 periods. The last bar in an I Wave up is counted as the first bar in the I wave down and vice versa. To further explain this concept consider a V Wave example. If you have an I Wave that is formed with 9 up-trending bars, they are labeled 1 to 9. Then a new I Wave descends with 9 down-trending bars. The two I Waves have created a V wave. The top bar is counted in the up move as 9 and in the down move as 1. However, there are only 17 bars in total. See the diagram below for a visual explanation.
9 Up + 9 Down = 18. 1 period is subtracted ( 9 + 9 – 1 = 17 ) and you have an accurate count.
The Ichimoku Cloud time principle uses numbers to predict how many bars in the future a turning point will occur. Consider the N wave pattern in the diagram Ichimoku Time below.
The N wave forms with an initial move down of 9 bars (A – B), then 5 bars up ( B – C), and lastly a push down of 11 bars ( C – D). The total move would be calculated at ( 9 + 5 + 11 = 25 ), however, 2 bars would have been double-counted bars thus the complete move would be 23 bars. As the market now turns up the projection for the end of the up move should be about 23 bars. The move from D – E, an I Wave turns at 22 bars.
Now moving forward, an I wave forms another leg down (E -F ). The prediction would be for 22 bars. It stops a few bars short, but the time principle has given a good overall estimate for when to anticipate market turns.
Diagram Ichimoku Time:
Ichimoku Cloud analysis is a combination of the 5 Ichimoku Cloud lines used with waves, price targets, and timing numbers. Each element by itself is limited. The key is to understand each principle and how they work together for effective Ichimoku Cloud trading.
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Pe´loille, Karen. (2017). Trading with Ichimoku: a practical guide to low-risk Ichimoku strategies. Petersfield, Hampshire: Harriman House Ltd.
Linton, D. (2010). Cloud charts: trading success with the Ichimoku Technique. London: Updata.
Elliot, N. (2012). Ichimoku charts: an introduction to Ichimoku Kinko Clouds. Petersfield, Hampshire: Harriman House Ltd.
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