An Introductory Guide on Ichimoku Cloud

Every trader enters the market, hoping to book profits. As a trader, you need to back your trades with detailed research and analysis. Consider various factors about the scripts you are investing in such as the performance of the company, its management, upcoming announcements, etc. You can also base your investments by analysing several tools, charts, patterns and technical indicators. Here is a helpful introductory guide on the Ichimoku cloud indicator.

Ichimoku cloud – meaning and definition

Ichimoku cloud is defined as a group of technical indicators, which show the support and resistance levels during intra-day trading sessions. Developed by the Japanese journalist Goichi Hosada, these indicators were first mentioned in a book he authored in the 1960s. The trading cloud also demonstrates the momentum and trend directions along with the support and resistance levels. The indicator takes various trading averages and plots them on the charts, while also using the figures to calculate a “cloud” that tries to forecast the point where the script’s price may find the support or resistance on a future date.

The Ichimoku indicator offers more data points than those provided by a standard candlestick chart. Although the charts may appear quite complicated in the beginning, once you learn how to read them, they become increasingly familiar, and you can decode them easily with properly defined trading signals.

Ichimoku cloud formulae

The Ichimoku cloud comprises of five lines, also known as calculations or formulae. Of these, two lines compose a cloud in which the difference between those two lines is shaded in. The lines in the cloud also comprise of a nine-period average, 26-period average, 52-period average as well as an average composed of those two averages and finally, a lagging closing price line. Here are the five formulae for the lines composing the Ichimoku cloud indicator:

  1. Conversion Line (Kenkan sen) = 9-PH+9-PL/2
  2. Base Line (Kijun sen) = 26-PH + 26-PL/2
  3. Leading Span A (Senkou span A) = CL + BL/2
  4. Leading Span B (Senkou span B) = 52-PH + 52-PL/2
  5. Lagging Span (Chikou Span) = Close Plotted 26 periods in the past

In the above formulae

  1. PH = Period High
  2. PL = Period Low
  3. BL = Base Line
  4. CL = Conversion Line

Step by step guide to calculating the Ichimoku cloud

While calculating Ichimoku, the highs are the highest prices seen during a trading period, while the lows are the lowest prices. For instance, it could be the highest as well as the lowest prices over the last nine days, if we consider the Conversion Line. You can automatically add the Ichimoku cloud indicator to your calculation chart to get the results. However, if you choose to undertake your calculations manually, you need to follow these seven easy steps. Here is a step by step guide.

1. The first step is to calculate the conversion line and the base line.

2. Next, you need to check your prior calculations, and based on it; you should calculate the Leading Span A. Once you complete this calculate, you will see the data point plotted at 26 periods into the future.

3. Now, you need to calculate Leading Span B. Just like with Span 1; you have to plot the Span B data also at 26 periods in the future.

4. Next is the lagging span. Here you have to plot the closing price at 26 periods in the past on your technical analysis chart.

5. You will now notice the difference between Span A and B is coloured in, which in turn creates the Ichimoku cloud.

6. When you see the Leading Span A above the Leading Span B, you can colour the cloud in green. Conversely, if the Leading Span A appears below the Leading B, you can colour the cloud in red.

7. The six steps mentioned above will now create a single data point. To create the lines whenever each period ends, you have to go through the above steps once again. This will help create new data points for every period. Finally, you can connect all the data points and create the appearance of the lines and clouds.

Decoding the Ichimoku cloud trading strategy – what does it tell you

Here’s how you can decipher the Ichimoku cloud:

1. Up, down and Static Trends

By employing the Ichimoku trading strategy, you can see the relevant information about your trade at a glance, by using averages. The overall trend goes up when the price rises above the cloud. Conversely, the trend goes down when the price falls below the cloud. However, when the price stays in its position in the cloud, the trend or transition ceases to exist.

2. Confirming the trend

When a trend is established, it is typically assigned a colour. So, if Leading Span A rises above Leading Span B, the uptrend is said to be confirmed, and the space between the lines can be seen coloured in green. Conversely, if Leading Span A falls below Leading Span B, it establishes a downtrend, with the space between the lines being coloured in red.

3. The support and resistance aspect

As a trader, you will often use the Ichimoku cloud as a support and resistance area, based on the relative location of your script’s market price. You can also get the support and resistance levels, which may be projected for future trades. It is this virtue that sets the Ichimoku trading cloud apart from most other technical indicators, which typically provide only support and resistance levels for current trades.

Applying the Ichimoku cloud trading strategy to your advantage

As a trader, you should consider using the Ichimoku cloud strategy by combining it with a few technical indicators. This can help maximise your risk-adjusted returns. For instance, you can pair the cloud strategy with the Relative Strength Index to confirm momentum of a script’s price in a specific direction.

You can also use the Ichimoku indicator for crossovers. Here you need to watch the conversion line and see if it moves above the baseline, mainly when prices are above the cloud, which serves as a powerful buying signal. You may also hold the trade until the conversion line drops below the baseline while using any other line as an exit point.

Final note:

There is no doubt that the Ichimoku cloud strategy is slightly complicated. You need to understand it in detail before employing it. Reach out to an Angel One Expert for more information on Ichimoku and other trading strategies.