Japanese journalist Goichi Hosoda created Ichimoku. He spent most of his time writing drafts on trade in the Japanese rice market. He understood how the price moved on the chart and how it reacted to certain situations. After a while, he discovered that the price of rice moved by specific rules, which we now call the levels of support and resistance. Goichi’s goal was to create an indicator showing “all the information in one,” which would allow a more accurate analysis of the chart by spending less time on it.
What is the Ichimoku Kinko Hyo indicator?
The Ichimoku indicator is built on three theories.
Hosoda put three pillars based on the Ichimoku Kinko Hyo indicator – time theory, wave theory, and price theory.
Time theory
The theory of time, also called the theory of numbers, are significant parameters of the indicator. Three main parameters: 9, 18, and 26. Why exactly these numbers? The fact is that at that time, the working week in Japan was six days, which gives us the values of one and a half weeks (9), three weeks (18), and a full working month (26), respectively. The remaining values are 33, 42, 65, 76, 129, 172. However, since these parameters were developed for markets at other times and for a 6-day working week, currently, some of the traders using Ichimoku change the settings so that they match with a 5-day rhythm of exchanges.
Wave theory
It is believed that Hosoda knew the theory of Elliott waves, but he did not establish exact rigid frames for the Ichimoku waves. They were based on the assumption of impulse, correction, and continuation, and were relatively simple.
Price theory
Price theory tried to answer the question of where the target for the next wave movement will be. Where is the correct range for wave I, or how far will the continuation of wave V will go? Thus, all three theories form one coherent technique.
How the Ichimoku Kinko Hyo indicator works
The setup consists of 5 separate linear indicators. Each component is calculated using strictly defined mathematical models. The calculation method is not important here. The main thing is to know how to use individual elements of the system.
The main components of Ichimoku are:
- Senkou Span A – First Leading Line
- Senkou Span B is the second guideline, both of these lines form a cloud together
- Tenkan Sen – turning (return) line
- Kijun Sen- baseline
- Chikou Span – Delayed Line
Look at the chart with the Ichimoku indicator installed on it. The idea of the indicator itself is to easily find the trend and corrections, as well as possible reversals. Thanks to the color scheme and clarity of Ichimoku, the trader should already, at a glance, evaluate whether the chart is imbalanced and whether it offers an opportunity.
Goichi Hosoda determined that the numbers 9, 26, and 52 are numbers that perfectly match the settings used in Ichimoku (why so, we wrote above). The space between the lines of Senkou Span is called the cloud (Kumo). If the price is between these lines, we are talking about a sideways trend, and the lines act as support and resistance levels.
- Kijun Sen – blue baseline, calculated as (highest level + lowest level) / 2 for the last 26 periods
- Tenkan Sen – red turning line., Calculated as (highest level + lowest level) / 2 for nine periods.
- Chikou Span – a green line shifted back by 26 periods, the closing price of the current candle.
- Senkou Span :
- Senkou A – brown line, (TenkanSen + KijunSen) / 2 shifted forward by 26 candles; average between green and red curve;
- Senkou B – purple line, calculated as (highest price + lowest price) / 2 for the last 52 periods, shifted by 26 candles ahead
Although, at first glance, Ichimoku may look complicated, in fact, it is based on correctly configured averages. And therefore:
- Tenkan sen (fastest average) indicates half between the highest peak and the lowest trough in 9 periods.
- Kijun Sen (slower average) corresponds to half the range of 26 periods.
- The cloud, on the other hand, is formed from the middle of Kijun Sen and Tenkan Sen (Senkou Span A), as well as the average for the last 52 periods.
Please note that the parameters refer to days because initially, Ichimoku was calculated for trading on daily charts.
Note that the Kumo Cloud is shifted 26 periods ahead, creating the illusion of a forecast for the right side of the chart. It is important to remember that this is still only an assumption based on previous prices.
Using the Ichimoku Kinko Hyo indicator in practice
When viewing a chart with the Ichimoku indicator installed, you probably notice the existence of several price areas:
- Cloud – indicates a possible trend direction or lack of a trend (when the cloud is intertwined, goes sideways, or when the price is in the cloud). According to the traditional approach, when the price is in the cloud, we do not trade. However, you can look for opportunities when exiting the cloud (continuation or reversal of the trend)
- Between the cloud and the middle Tenkan sen and Kijun Sen., It is assumed that the price is in correction and will either accelerate the breakthrough of Kijun Sen, continuing the trend, or enter the cloud.
- The price below Kijun and Tenkan-sen in a downtrend and above these lines in an uptrend is a “healthy” situation, indicating the strength of the trend and the potential for the development of an impulse.
- Between Kijun and Tenkan-sen. We are still waiting for a test of a slower average, which may be support/resistance, protecting the trend and breaking the faster average to continue the trend.
Ichimoku Kinko Hyo trading strategy
Consider the components of Ichimoku in more detail.
Cloud – trend confirmation
The trading system can be based on a cloud created by Senkou Span lines. The cloud illustrates the current trend on the chart. When the price (candle) enters (penetrates) the cloud below, you can look for the possibility of opening a long (buy) transaction. If the price penetrates the cloud from above, you may consider a short (sell) position. When the price is above the cloud, this means that the pair is always in an uptrend. If it is below the cloud, this means that the pair is in an downtrend. This strategy can help to give the trader a good understanding of the market and trends.
To summarize, the basic strategy would be to buy when the price is above the cloud, and sell when the price is below the cloud. Of course, this can be confirmed using additional chat analysis.
Tenkan Sen (fast) and Kijun Sen (slow)
In a trend, you can trade using two lines: fast and slow. The fast line is calculated based on the last nine periods, and the slow line is calculated based on the last 26 periods, so the Tenkan Sen line moves faster than Kijun Sen. The fast line is always closer to the price
In the figure below, the fast line is green, and the slow line is pink. But when the fast line crosses the slow line from the bottom up, and sell when the fast line crosses the slow line from the top down. Clouds and lines can be used separately; however, if both give the same signal, the signal could be considered stronger.
Using the “half” ( see the formulas above, where the values are divided by 2 ) from a given period makes the Ichimoku lines dynamic, moving support and resistance levels, which are built in accordance with the volatility and direction of price movement.
Chikou Span as an entry confirmation
Chikou Span gives additional confirmation. Chikou Span is a line that works as an additional confirmation. Therefore, some traders can open positions only when the line indicates such an opportunity. When they are patient enough to wait for the signal coming from the Chikou Span, as shown in the figure below. Even when the cloud has no good signs, the Chikou Span line works!
To summarize, when Chikou Span is above the cloud, a trader may look to open long positions, and when below the cloud, they may look for short positions.
So, the main signals given by the Ichimoku indicator are:
- The candle closes above/below the cloud. In the case when the candle closes above the rising cloud, it generates a buy signal, and when it closes below, it generates a sell signal. Of course, in this case, they can generate false signals. Therefore, additional market analysis would be needed.
- When a faster average value (Tenkan sen) breaks through a slower one (Kijun sen) from below – a potential buy signal is generated.
- When a faster average (Tenkan sen) breaks a slow (Kijun sen) from above – then a potential sell signal appears.
- When the Chikou Span is above the cloud, the trader receives information that it may be worth looking only for long positions.
- When Chikou Span is below the cloud, this confirms the bear market and the trader may consider opening only short positions.
Of course, depending on where the intersection with the cloud (Kumo) occurs, the signal may be weak, strong, or neutral. A signal can be considered weak when a buy signal is generated below the cloud, or a sell signal is generated above the cloud. Similarly, when two environments intersect above the cloud, a strong buy signal is generated, and below the cloud, a strong sell signal is generated.
If the intersection occurs in the cloud, then this signal is called neutral, and we are waiting for the generation of stronger signals. Such signals will even include a breakthrough in prices from the area of consolidation (clouds).
Ichimoku Kinko Hyo indicator stop loss & take profit
The Ichimoku strategy also presents possible areas to place stop losses, take profits and from where to conisder exiting a trade position manually.
Stop Loss – fast line, slow line, and cloud may be potential support and resistance levels. In the case of a breakthrough of the support or resistance level, the price may gain momentum, which will direct it to the next support or resistance.
Therefore, you could set a stop loss on the other side of the cloud or the other side of a slow or fast line. Once the price reaches our level, you could exit the current position. Also, when you have a long position, the stop loss may be slightly lower than the last trough, while in the case of a short position, the stop loss may be several pips above the last peak.
Take profit – as an option. A position can be closed when a signal appears that is opposite to the one you entered. That is, if you are in a long trade, then you may close the position when the line (Tenkan sen) breaks through the slow (Kijun sen) from top to bottom.
Ichimoku Kinko Hyo indicator conclusion
The Ichimoku Kinko Hyo is not only an indicator but it’s a complete methodology of trading based on price theory, wave theory and time factor. It looks a little complicated at first glance but it can be very useful if you take the time out to understand the components of the indicator.
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