How to Use the Ichimoku Cloud Trading Strategy

In today's fast-paced financial markets, mastering effective trading techniques is a key element of success, and the Ichimoku Cloud trading strategy stands out as a versatile tool for identifying trends, generating buy or sell signals and managing risk. This increasingly popular indicator also provides traders with clear trading signals, as well as initial and secondary support and resistance levels. 

Whether you're a novice trader seeking to expand your knowledge or an experienced market operator looking for a new technical approach, this Benzinga article will help you delve into the intricacies of the Ichimoku Cloud, offering practical insights and actionable tips to enhance your trading profitability, so keep reading to learn more. 

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What is Ichimoku Cloud Strategy?

In Japanese, the name of the Ichimoku Cloud indicator is the Ichimoku Kinko Hyo (IKH), which literally means “chart equilibrium at a glance.” The indicator and the technical analysis technique for its use originated in pre-World War II Japan by Tokyo journalist Goichi Hosod, but the technique was not released to the general public until the late 1960s. 

The Ichimoku Kinko Hyo indicator appears to work best on daily and/or weekly charts, and it provides a wealth of relevant trend direction information for forex traders that include actionable trade signals. Traders generally use the IKH indicator to reveal the existence and direction of a trend and to show where initial and secondary support and resistance levels exist in the market. 

Understanding the Ichimoku Cloud Components

The Ichimoku Cloud indicator consists of five main components in the form of lines. Each of the lines has traditional Japanese names and is commonly colored as follows:

The Tenkan-Sen or Conversion Line

This line is plotted in red and consists of a fast moving average that is calculated by averaging the highest high over a specific time span that typically consists of nine periods. This line illustrates short-term trends and signals.  

The Kijun-Sen or Base Line

The Kijun-Sen is plotted in maroon and consists of a slower moving average calculated in the same manner as the Tenkan-Sen. This moving average is taken over a longer time period of typically over 26 periods. It helps traders identify medium-term trends. 

The Chikou Span or Lagging Span

This line is generally plotted in pink and represents the current closing price or exchange rate level. The Chikou Span is plotted backward for 26 periods and lets traders assess the strength of the current trend.   

The Senkou Span A and B

The Senkou Span A is typically plotted in green and represents the average of the Tenkan-sen and the Kijun-sen plotted forward for 26 periods. This line delineates the first boundary of the “cloud” or “kumo” in Japanese. The Senkou Span B line forms the second boundary for the cloud and is plotted in blue. The Span B line is calculated by averaging the highest high and lowest low over a longer time period of typically 52 periods. It is plotted forward for 26 periods.

Kumo or Cloud

This term is used to describe the area between the Senkou Span A and the Senkou Span B lines. The cloud shows the support and resistance levels, while the thickness of the cloud reflects the volatility in the market. If the market is trading above the cloud, this indicates bullish sentiment and a possible buy signal, while if the market is trading is below the cloud, this would indicate that bearish sentiment prevails so the market may be in a potential downtrend. 

The five components of the Ichimoku Cloud indicator work together to give traders a comprehensive view of the market trend and support and resistance levels. Used in conjunction with other technical analysis tools and market indicators, the Ichimoku Cloud could indicate potential trading opportunities. 

Identifying the Trend

Identifying a market trend using the Ichimoku Cloud indicator can be accomplished by following these steps:

Step 1: Determine Position

First, you must determine the position of the exchange rate relative to the cloud. If the exchange rate is above the cloud, this would indicate a bullish trend, possibly suggesting a buying opportunity. By the same token, if the exchange rate is below the cloud, this would indicate a bearish trend and possibly an opportunity to go short the market. 

Step 2: Assess Color and Thickness

After you have determined the current position of the exchange rate relative to the cloud, you would assess the color and thickness of the cloud. The cloud’s color often signals a bullish trend if green and a bearish trend if red. The thickness of the cloud indicates the strength of the trend, with a thicker cloud indicating higher volatility and stronger support and resistance levels. 

Step 3: Observe Line Interactions

The next step is to observe how the Tenkan-sen (Conversion Line) and Kijun-sen (Base Line) interact. These interactions can indicate dynamic support and resistance levels. Also, when the Tenkan-sen crosses above the Kijuin-sen, the indicator generates a bullish trading signal, while if the Tenkan-sen crosses below the Kijun-sen, it generates a bearish signal. 

Step 4: Confirm Trend with Chikou Span

Finally, the position of the lagging Chikou Span provides confirmation of the trend based on historical exchange rate performance. If the Chikou Span is above the exchange rate, this indicates a bullish signal, while a Chikou Span below the exchange rate indicates a bearish signal. 

By following the previous four steps and taking all of the above factors into consideration, you can get a good idea of the prevailing trend of an asset as well as its price action and price movement. Still, obtaining a comprehensive analysis requires you to use the Ichimoku Cloud indicator in conjunction with other technical tools and indicators for a more in-depth analysis of market conditions. How to do that is discussed further below. 

Identifying Trading Signals

To identify a trading signal with the Ichimoku Cloud indicator, a buy or sell signal can be generated using the criteria below:

• Kijun-sen or Tenkan-sen Crossover: When the Tenkan-sen or Conversion Line crosses above or below the Kijun-sen or Base Line, a trading signal is generated. If the Tenkan-sen conversion line crosses above the Kijun-sen base line, this would indicate a buy signal. If the Tenkan-sen conversion line crosses below the Kijun-sen line, this would generate a sell signal.  
• Exchange rate relationship with cloud: Ideally, you want to look for situations where the exchange rate crosses above or below the cloud. When the exchange rate moves above the cloud from below the cloud, this would generate a buy signal. Conversely, when the exchange rate moves from above the cloud to below the cloud, this would generate a sell signal. 
• Confirmation from Chikou Span Line: If the Chikou Span or lagging line is above the exchange rate, this would imply a bullish signal to buy the currency pair, while if the Chikou Span line is below the exchange rate, then that bearish signal indicates selling would be the better option. 

Conversion-Base Line Signals

Conversion-base line signals generated by the Ichimoku Cloud indicator alert traders to potential changes in the prevailing trend’s direction. These signals are generated when the Tenkan-sen conversion line crosses above or below the Kijun-sen base line. Read more about the signals and how they manifest below.  

• Bullish signal: When the Tenkan-sen conversion line crosses above the Kijun-sen base line a potential shift from bearish to bullish could be unfolding. This gives observant traders a clear buy signal or a signal to cover their short positions. 
• Bearish signal: The bearish signal is the opposite of the bullish signal and occurs when the Tenkan-sen conversion line drops below the Kijun-sen base line. This indicates the market could be shifting from bullish to bearish, and provides traders with the opportunity to sell out any long positions and/or go short the market.  

Price-Kijun-sen Base Line Signals

This Ichimoku Cloud indicator allows a trader to examine the relationship between a currency pair’s exchange rate and the Kijun-sen base line to help them identify trend reversals. The bullish and bearish price-Kijun-sen base line signals are:

• Bullish signal: A bullish signal develops when the exchange rate crosses above the Kijun-sen base line. This suggests a potential shift from a bearish to a bullish trend and could be interpreted as a buy signal. 
• Bearish signal: A bearish signal occurs when the exchange rate dips below the Kijun-sen base line, thereby suggesting a shift from a bullish to a bearish trend. When this bearish signal occurs, traders can sell out their long positions and/or establish a short position to profit from the trend reversal. 

Combining Ichimoku Cloud with Other Technical Analysis Tools

Using other confirming technical indicators such as moving averages, support and resistance levels and market volatility can make your Ichimoku Cloud trading signals significantly more accurate. Below are the most common technical indicators to use along with the Ichimoku Cloud indicator: 

Moving Averages

Using a 50- or 200-day moving average can help you identify the direction of the market’s overall trend. Look for alignment of these long-term moving averages with the Ichimoku Cloud signals for further confirmation of the trend and the strength of the indicator’s trading signals. 

Candlestick Patterns

Using candlestick chart patterns such as engulfing, hammer or doji star patterns can help you identify potential trend reversals or continuations. The signals from these patterns carry more weight when aligned with the Ichimoku Cloud’s signals. 

Support and Resistance Levels

These levels can be read from exchange rate charts and further confirmed by alignment with the Ichimoku Cloud indicator’s boundaries and other components.

Fibonacci Retracement Levels

Many traders use the Fibonacci retracement levels to identify potential levels of support and resistance during a market correction. They can be further confirmed using the Ichimoku Cloud indicator. 

Oscillators

Overbought and oversold conditions indicated by oscillators like the relative strength index (RSI) can be further confirmed using the Ichimoku Cloud indicator. The key to combining such indicators is looking for divergence between the oscillator and the exchange rate that can signal a potential trend reversal. Such reversals can be further confirmed using signals from the Ichimoku Cloud indicator.

Remember, combining multiple technical trading tools should only be done with a proper understanding of how to use these market analysis methods profitably. You will also want to avoid overcomplicating your technical analysis so that you can take quick and decisive action, and be sure to use basic risk- and money-management principles when trading. 

Backtesting a new trading strategy on historical data can help you evaluate the effectiveness of a combined approach using the Ichimoku Cloud indicator before applying the strategy to a live trading environment. Many traders also find it helpful to practice trading any new strategy in a demo account first. 

Would the Ichimoku Cloud Indicator Improve Your Trading?

Using the Ichimoku Cloud combined with other technical indicators could potentially benefit any trader with the patience and expertise required to use the indicator correctly to generate buy and sell signals. Many technical indicators like the Ichimoku Cloud and other market analysis tools also mainly benefit traders who can maintain a disciplined and strategic approach to their trading activities. 

As a first step toward using the Ichimoku Cloud indicator, you can try incorporating one or more strategies that use it into your market analysis and trading plan. Keep in mind that the indicator is best used in combination with other technical indicators widely used for generating and confirming trading signals. 

Remember to backtest your new Ichimoku Clould forex trading strategy thoroughly in a demo account. This lets you gauge how effective its trading signals would have been historically and gives you an opportunity to refine your strategy before trying to trade it in a live account.  

Frequently Asked Questions 

Disclosure: Benzinga was commissioned for this article and is not affiliated with CedarFX. Any comments or opinions provided herein are Benzinga's. CedarFX does not endorse or promote any trading strategies that may be discussed or promoted herein. The broker makes no representation or warranty as to the article's adequacy, completeness, accuracy or timeliness for any particular purpose of the above content.

This presentation discusses technical analysis, other approaches, including fundamental analysis, may offer very different views. The examples provided are for illustrative purposes only and are not intended to be reflective of the results you can expect to achieve. This article is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. Investing involves risk regardless of the strategy selected and past performance does not indicate or guarantee future results. Trading leveraged products such as Forex and Cryptos may not be suitable for all investors as they carry a degree of risk to your capital.