The Ichimoku Cloud is a group of indicators that are used together to form a trading system. While the name implies that this is a single cloud, the reality is that the Ichimoku is a group of clouds that can be used to create trading signals. This grouping of clouds creates an equilibrium chart that can be used to find specific information within a trend, as well as the support and resistance levels, which can assist you with risk management. Additionally, the cloud provides trend following, momentum, and overbought/ oversold signals. The Ichimoku Cloud was developed by the journalist Goichi Hosoda and published in his 1969 book.
The Ichimoku Cloud Calculation
Goichi Hosoda created default calculations that describe what is encapsulated in the Ichimoku Cloud. The first default setting provides information that describes the conversion line, the baseline and the cloud formation.
- Tenkan-sen is the 9-period moving average. The moving average is the average of the high and the low on a specific day. The MT4 charting software offered by Rakuten Securities Australia automatically generates this calculation.
- Kijun-sen is the baseline or Kijun-sen which is the 26-period moving average, calculated by adding the high and low and dividing them by two over the 26-periods.
- The Senkou Span A is the mid-point between the conversion line and the baseline.
- The Senkou Span B is calculated by finding the average between the 52-period high and the 52-period low.
- The Chikou Span is the daily close of an exchange rate or asset during the past 26-days.
How to Trade Using the Ichimoku Cloud
You can use the Ichimoku cloud in multiple ways to identify a trend within a currency pair. The first technique is straight forward. When the price of a currency pair is above the cloud, an uptrend is in place. When prices are below the cloud, a downtrend is in place. When the prices are at the cloud, then the trend is neutral. A second way to determine a trend is to evaluate the strength of the trend. When the leading span A (the green cloud line) is rising and is above the Leading Span B which is the red cloud line an uptrend is considered in place. A downtrend is considered to be in place when the green cloud line is declining and is below the red cloud line. When the 9-period moving average is above the 26-period moving average an uptrend is in place. Conversely, when the 9-period moving average is declining and is below the 26-period moving average a downtrend is in place.
Ichimoku Cloud Signals
You can use a combination of the exchange rate of a currency pair, the conversion, and baselines to identify signals. The most efficient bullish signals occur when the exchange rate is above the cloud. The most efficient bearish signals occur when the exchange rate is below the cloud. The underlying theme is that you want to trade in the direction of the trend.
Bullish and Bearish Crossover Signals
Conversion-Base Line Signals occur when either the conversion line crosses below the baseline (bearish signal) or the conversion line crosses above the baseline (bullish signal). In the chart of the GBP/USD, the bearish signal that occurred in February happened with the exchange rate was below the cloud and the conversion line crossed below the baseline. You can see that in early June 2020, the conversion line crossed above the baseline when the exchange rate was above the cloud. There are several scenarios where the conversion line crosses above or below the baseline, but not as many occur when the trend is pointing in the direction of the signal.
Short-term Price to Base Line Signals
Within the larger trend, there are short-term overbought and oversold signals that are created with a combination of the exchange rate and the baseline. With the price trading above the cloud, a pull-back in the exchange rate will occur when the exchange rate moves below the baseline. When this occurs there is a decline in the exchange rate which is part of the larger trend. This creates the setup. When the exchange rate rises back above the baseline a bullish signal is generated. Alternatively, a bearish price to the base line would initially begin when the exchange rate is trading below the cloud. The exchange rate will rise above the baseline. When it declines below the baseline a short-term bearish signal is generated.
Momentum, Trends, and Overbought-Oversold Triggers
The Ichimoku Cloud is a comprehensive trading tool that incorporates trends, momentum, and overbought/oversold triggers. Recall, a bullish trend is in place when the price is above the cloud. Momentum accelerates when the conversion signal crosses above the baseline. This is similar to the crossover buy signal generated by the MACD (moving average convergence divergence) If the price moves below the baseline when the price was above the cloud before the move, an oversold trigger is kicked off generating a buy signal. The bearish signal also has these three components. When the price is below the cloud a bearish trend is in place. A bearish momentum signal is kicked off when the conversion line crosses below the baseline. If the exchange rate rises above the baseline and the exchange rate is below the cloud initially, then when the exchange rate crosses back through the baseline an overbought bearish trigger is activated
The Bottom Line
The Ichimoku Cloud provides a trading system that gives many different bullish and bearish signals. It was first introduced by journalist Goichi Hosoda and published in his 1969 book. Your MT4 offered by Rakuten Securities Australia will provide all the default settings to allow you to view the signals in real-time. If you are interested in changing the default calculations the process is as simple as changing the settings. You can use the Ichimoku Cloud system to identify trends, as well as to find momentum and overbought/oversold signals.