Ichimoku Cloud: Explanation, Calculation, and Trading Tips

What Is the Ichimoku Cloud?

The Ichimoku Cloud is a technical analysis tool combining various indicators to provide a complete view of the market.

Originally developed by a Japanese journalist, Goichi Hosoda, in the 1960s, the Ichimoku Cloud is often called Ichimoku Kinko Hyo, which translates to "one glance equilibrium chart."

That’s a mouthful, but it reflects the indicator’s purpose: to give traders a quick and comprehensive overview of market trends, momentum, and potential support and resistance levels.

The Ichimoku Cloud is unique because it shows the current market trend and predicts future market movements. This feature makes it a valuable resource for traders in various financial markets, such as forex trading, shares, commodities, and more.

As you can see in the chart above, the Ichimoku cloud consists of five key components: Tenkan-sen, Kijun-sen, Senkou Span A, Senkou Span B, and Chikou Span.

Let’s explore how each of these Ichimoku components contributes to this indicator.

What Are the Tenkan Sen and Kijun Sen?

The Tenkan-sen and Kijun-sen are two essential lines in the Ichimoku Cloud that help identify short-term and long-term trends.

• Tenkan-sen (conversion line) is calculated by averaging the highest high and the lowest low over the past nine periods.
  It represents a short-term trend indicator and often acts as a momentum indicator.

• Kijun-sen (baseline) is calculated similarly but over the past 26 periods.
  This line serves as a longer-term trend indicator and is often used as a reference for setting support and resistance levels.

When these two lines cross, it can signal a potential trend reversal or continuation, making them very important for trading strategies.

What Are the Senkou Spans Used in Ichimoku Clouds?

The Senkou Spans form the cloud in the Ichimoku Cloud system, creating a shaded area that helps visualize future support and resistance levels.

• Senkou Span A: This line is calculated by averaging the Tenkan-sen and Kijun-sen, then plotting the result 26 periods ahead of the current price.
  Senkou Span A represents one edge of the cloud.

• Senkou Span B: This line is calculated by averaging the highest high and lowest low over the past 52 periods and is also plotted 26 periods ahead.
  It forms the other edge of the cloud.

The space between these two lines is the cloud chart, where traders can see potential future market trends.

What Is the Chikou Span in Ichimoku Clouds

The Chikou Span, or lagging line, is the final component of the Ichimoku Cloud. It is the current closing price plotted 26 periods back on the chart.

The Chikou Span is used to confirm trends and support and resistance levels.

What Does the Ichimoku Cloud Tell You?

Now that you know each component of the Ichimoku cloud, let’s understand how to interpret it correctly.

Here’s a guideline on how to interpret the Ichimoku cloud.

1. Cloud (Kumo):

The cloud is formed between Senkou Span A and Senkou Span B.

• Bullish cloud (uptrend): If Senkou Span A is above Senkou Span B

• Bearish cloud (downtrend): If Senkou Span B is above, Senkou Span A

Price Position:

• Above the Cloud: Indicates an uptrend.

• Below the Cloud: Indicates a downtrend.

• Within the Cloud: Suggests consolidation or a neutral trend.

2. Tenkan-sen and Kijun-sen:

• Tenkan-sen: A rising Tenkan-sen indicates an uptrend, while a falling one suggests a downtrend.

• Kijun-sen: Can act as a support or resistance level.

Moreover, the crossovers of these two lines are also significant signals:

• Bullish Signal: When Tenkan-sen crosses above Kijun-sen, it signals a potential buy.

• Bearish Signal: When Tenkan-sen crosses below Kijun-sen, it signals a potential sell.

3. Chikou Span (Lagging Span):

If the Chikou Span is above the past prices, it confirms a bullish trend. If it’s below, it confirms a bearish trend.

4. Cloud Thickness:

The thickness of the cloud indicates the strength of support or resistance. A thicker cloud suggests stronger support or resistance, while a thinner cloud suggests weaker levels.

How to Calculate the Ichimoku Cloud

Calculating the Ichimoku Cloud involves several steps, each corresponding to the various components we’ve discussed.

Ichimoku Cloud Calculation

Here’s a breakdown of the formulas for the ichimoku cloud:

The Difference Between the Ichimoku Cloud and Moving Averages

While both the Ichimoku Cloud and moving averages are used to spot trends, they work differently. Moving averages look at past prices to smooth out data and show trends but only reflect what's already happened.

On the other hand, the Ichimoku Cloud not only shows current trends but also predicts future movements. Its ability to predict future support and resistance levels makes it a more flexible and useful tool for analyzing the market.

How to Use Ichimoku Cloud

You can develop various trading strategies using the Ichimoku Cloud, from trend following to breakout strategies.

Here’s how you can get started:

How to Add the Ichimoku Cloud Indicator in MT4 and MT5?

Adding the Ichimoku Cloud to your trading platform is straightforward.

In both MT4 and MT5:

1. Open your trading platform and select a chart.

2. Click on “Insert” and go to the "Indicators" tab.

3. Hover over “Trend” and  click on "Ichimoku Kinko Hyo."

4. Customize the settings as needed.

Entry and Exit Signals Using the Ichimoku Cloud?

When using the Ichimoku Cloud to determine entry and exit points, focus on the price's relationship to the cloud:

• Entry Signal: Consider buying when the price moves above the cloud, as this suggests the start of an upward trend.

• Exit Signal: Think about selling when the price falls below the cloud, which may indicate the beginning of a trend reversal.

How to Set a Stop Loss Using the Ichimoku Cloud?

To protect your trades, setting a stop loss based on the Ichimoku Cloud can be very effective:

• For Long Positions: Place your stop loss just below the Kijun-sen or the lower edge of the cloud. This helps safeguard your trade if the trend reverses.

• For Short Positions: Set your stop loss just above the cloud or the Kijun-sen. This ensures your position is protected in case the market moves against you.

What Is the Best Time Frame for the Ichimoku Cloud Indicator?

The Ichimoku Cloud can be applied across different time frames, but it tends to be most effective on longer ones, such as daily or weekly charts. These time frames provide a clearer picture of market trends.

However, the Ichimoku Cloud best time frame is the shorter time frames, particularly in fast-moving markets like Forex trading, where quick decisions are crucial.

Ichimoku Trading Strategies

The Ichimoku Cloud is a good indicator to incorporate into your trading strategies. Putting everything that we've mentioned above together, here are some actionable trading strategies.

Breakout Strategies

Breakout strategies focus on the cloud (Kumo) as a dynamic support and resistance zone.

As mentioned above, if the Senkou Span A is above Senkou Span B, this signals a bullish breakout. On the other hand, if the Senkou Span B is above, it signals a bearish breakout.

For example, consider you’re monitoring the EUR/USD daily chart. After a period of consolidation, the price breaks above the cloud with increasing volume. This breakout aligns with a green cloud and a bullish Tenkan/Kijun crossover.

You would enter a long position, placing a stop-loss just below the lower edge of the cloud to manage risk.

Additional tips:

• Always wait for a candle to close outside the cloud to confirm the breakout.

• Combine breakout signals with volume indicators to avoid false signals.

Tenkan/Kijun Crossovers

The Tenkan-sen (conversion line) and Kijun-sen (baseline) crossovers are vital signals for identifying potential entry and exit points.

These crossovers help traders determine the momentum and direction of the trend. When the Tenkan-sen crosses above the Kijun-sen, it signals a buying opportunity. Whereas when the Tenkan-sen crosses below the Kijun-sen, it signals a sell opportunity.

For example, a swing trader analyzing the GBP/JPY four-hour chart notices a bullish Tenkan/Kijun crossover above the cloud. Believing the trend will continue, they enter a long trade.

To exit, the trader waits for a bearish crossover or uses the Kijun-sen as a trailing stop to lock in profits as the trend progresses.

Additional tips:

• Use crossovers in trending markets to reduce the likelihood of false signals.

• Avoid trading crossovers within the cloud, as these are weaker signals.

Trend Confirmations

The Ichimoku Cloud excels in confirming trends by analyzing the price position relative to the cloud and the behavior of the Chikou Span (lagging line).

This strategy helps traders validate the strength and direction of the market before making a move.

How It Works:

• Uptrend: The price is above the cloud, the cloud is green, and the Chikou Span is above historical price action.

• Downtrend: The price is below the cloud, the cloud is red, and the Chikou Span is below historical price action.

For example, a position trader analyzing Tesla’s stock observes that the price remains consistently above the cloud on the daily chart, with the cloud widening (indicating strong support).

The Chikou Span confirms the bullish momentum by staying above past price action. The trader holds their long position, setting stop-loss levels at the Kijun-sen for added security.

Additional tips:

• Use the thickness of the cloud as an indicator of trend strength; thicker clouds suggest stronger trends.

• Combine trend confirmation with other indicators like RSI to validate momentum.

Which Other Technical Indicators Work Best with the Ichimoku Strategy?

The effectiveness of the Ichimoku cloud can be improved by combining it with other technical indicators like the below:

• RSI (Relative Strength Index): Confirms overbought or oversold conditions, complementing Ichimoku's trend signals.

• MACD (Moving Average Convergence Divergence): Enhances trend and momentum analysis when used with Ichimoku.

• Bollinger Bands: Helps identify breakouts or consolidations alongside the Ichimoku Cloud.

• Stochastic Oscillator: Fine-tunes entry and exit points by signaling overbought or oversold levels.

• Volume Indicators: Confirms the strength of trends when combined with Ichimoku signals.

Limitations of Using the Ichimoku Cloud

Despite its numerous advantages, the Ichimoku cloud has the below limitations:

• Can be challenging for beginners due to its multiple components and detailed analysis.

• It may sometimes provide delayed signals as a lagging indicator, particularly in fast-moving markets.

• The Ichimoku Cloud is less reliable in sideways or choppy markets, where it may produce false signals.

• The full display of the Ichimoku Cloud can make charts appear cluttered, complicating the analysis of other price actions or indicators.

Conclusion

The Ichimoku Cloud provides a detailed and clear understanding of the market. Its ability to predict future trends and key levels gives you a significant advantage in making informed trading decisions.