The Ichimoku Cloud is a central element of the Ichimoku chart technical analysis system aimed at forecasting price trends through a multi-dimensional visual representation of support and resistance levels.
Ichimoku Kinko Hyo
Since technical analysis came into common use in the 20th century, numerous charting systems have come into popularity. Many have specific strengths for given situations and purposes, such as identifying trend direction, support and resistance, and gauging price momentum. To give a complete view of price movements, the Ichimoku Kinko Hyo charting system attempts to gather and present all these functions simultaneously in an integrated fashion.
Ichimoku Kinko Hyo, which means "equilibrium chart at a glance," was developed by Japanese journalist and charting technician Goichi Hosada before World War II, and a completed version was published in 1968. Hosada was a keen observer of Japan's rice market and sought to devise a system describing the dynamics of price movements that could be interpreted at a glance. To build his system, he enlisted the help of several students, who performed back-testing of his price trend models on past market movements to confirm the models' validity. The system, which can be applied to price movements in any asset market, was widely adopted in Asia following its introduction, and came into popularity in the West in the 1990s.
The Ichimoku Chart At Work
The Ichimoku chart was originally formulated based on the traditional six-day Japanese trading week. Because of this, elements of the chart are customarily based on: a nine-day one-and-a-half week trading period; a 26-day trading month; and a 52-day period representing two months. Some technicians have suggested the chart may be adjusted in the U.S. and other markets for the five-trading-day week. However, the chart is often left at the standard Japanese intervals and adjusted according to the time horizon one is using for trading.
The Ichimoku chart includes five component lines, which were expected to be interpreted together, according to Hosada's original intent. The philosophy behind the chart is that it shows where the price is currently situated in relation to a theoretical "equilibrium" based on recent trading trends.
The Tenkan Sen is the shortest period line on the chart, and it represents the average of the highest high and the lowest low over the previous nine periods. This line, sometimes called "the turning line," is aimed at signaling fast-moving price momentum.
The Kijun Sen, or "standard line," is the second-shortest period line, and it represents the average of the highest high and the lowest low over a 26-period time frame. This is taken as a momentum indicator for the slower moving trend. It is also commonly used as an indication of support and resistance, and to suggest stop order price placement.
The Tenkan Sen and the Kijun Sen lines are frequently used in combination to suggest probabilities of future momentum and trigger points for entries to a trade.
The third-longest period line on the Ichimoku chart is the Chikou Span line, which represents the current closing price plotted 26 periods back from the present. This line, also known as the "lagging line," is often used to help confirm trends, momentum, and support and resistance.
The cloud, or kumo as it is known in Japanese, is one of the most visible and indicative elements of the Ichimoku system. The cloud is formed by the final two component lines of the system, known as the "Senkou Span A" and the "Senkou Span B."
The Senkou Span A, or "first leading line," represents the average of the Tenkan Sen line and the Kijan Sen line plotted forward 26 periods on the chart. The Senkou Span B, or "second leading line," represents the average of the highest high and lowest low over the past 52 periods plotted 26 periods forward on the chart. The area between the two lines defines the cloud.
Tracking Cloud Formations: Support, Resistance And The Trend
The purpose of the cloud in the Ichimoku system is to provide a dynamic, multi-dimensional view of probable support and resistance, and the trend that they will follow. The area on the chart within the cloud is understood to be an area of equilibrium and no trend, where there is little price certainty. Thus, trading is generally initiated when the price is above or below the cloud.
A price above the cloud signals a bullish trend and a price below indicates a bearish one, while a price within the cloud signals a range-bound state. The recommended trend for trading will then follow the cloud lines in an upward or downward direction, depending on the trade and the trend indicated by the cloud.
When the price is situated above the cloud, the top of the cloud indicates a first level of support and the bottom line the second level. Similarly, when the price is below, the bottom of the cloud indicates a first level of resistance and the top the second level. Additionally, as the Senkou Span lines that form the cloud are dynamic, the widening and narrowing of the cloud is understood to describe the potential price volatility that can occur within a given trend.
While some technical indicators offer a one-dimensional signal to suggest trading possibilities, the Ichimoku system provides a more complete visual picture of potential price movements. The system, and its central component, the Ichimoku cloud, can be used in conjunction with other technical indicators to determine the best entry and exit points for trading. Or they can be used entirely on their own as a self-contained price trend analysis system.
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Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…