The Ichimoku indicator or trading system is a rather recent development, originating in Japan back in the sixties. The system combines a variety of indicators to create an overall picture of the market, thereby providing traders with high probability trading signals. The system was used primarily in the commodities and futures markets, but forex traders have recently discovered its usefulness in their medium. Traders that handle positions over a few days are the main users, since the system works best over longer timeframes. The chart can appear visually complex, but signals are easily seen.
The Ichimoku trading system is classified as an “oscillator” since the various components fluctuate over and below pricing candlesticks for chosen time periods. The system also has the unique quality of extending into the future, while also depicting prior market sentiment. Nomenclature follows Japanese tradition, but the “cloud” is the distinguishing feature with three additional line indicators that help signal potential trading patterns and set-ups. Longer timeframes help eliminate market “noise” and increase the effectiveness of this technical support tool.
Ichimoku Component Formulas
The Ichimoku indicator is common on Metatrader4 trading software, and an example appears in the following chart for the 4-hour “EUR/USD” currency pair:
Here is a brief summary for each of the noted components:
- Kumo Cloud: These areas depict support and resistance, derived from previous pricing data. The borders of an “Up” Cloud are known as Senkou Spans A and B. Key alerts occur when candlesticks exit the “cloud”, various lines enter or pass through the designated regions, or when the cloud changes color;
- Tenkan-sen and Kijun-sen: These lines, similar to moving averages, are calculated from previous highs and lows over 9 and 26 periods, respectively. The “Green” line, or Tenkan-sen, is the quicker of the two, and its intersections are key trading signals, while its slope tends to measure momentum;
- Chinkou-span: This line measures market sentiment, based on current closing prices, but is moved backward typically 26 time periods. Its position relative to pricing data indicates if Sellers or Buyers are dominating the action, while the cloud’s position may portend resistance if it enters the picture.
The Kumo Cloud is used in many ways to form and confirm trading strategies. The areas represent support and resistance, while the width and breadth speak to volatility and strength. If prices are above the Cloud, it is a “bullish” condition, and below, a “bearish” condition. Twists and flips of the Cloud denote imminent changes in direction, and traders are counseled to withhold from trading when the candlesticks are within the Clouds Senkou Spans or boundaries.
The Ichimoku trading system provides “one look”, as its name implies, for the trader to interpret. Rather than relying on a single indicator to frame a “macro” view, the trader is given four integrated indicators to view the interplay of critical market variables. The Ichimoku indicator is useful in gauging medium timeframe momentum when compared to projected regions of support and resistance.
The next article in this series on the Ichimoku trading system will discuss how this oscillator is used in forex trading and how to read the various graphical signals that are generated.
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