Part of the Japanese approach to technical analysis, the Ichimoku Kinko Hyo indicator is extremely popular with retail traders.
It has plenty of reasons for that:
- It is visible. The cloud offers a clue about the main trend (bullish or bearish).
- The Kinjun/Tenkan cross signals possible reversals.
- The cloud also projects future support and resistance levels.
According to the Japanese, the Ichimoku indicator offers a state of equilibrium. It shows a balance between the past and future prices.
As such, the cloud projects future support and resistance levels on the right side of the chart. Or, twenty-six periods forward.
Of course, traders can change these settings. But it is not a good idea, as the Ichimoku is supposed to give the best results with the original ones.
Describing the Indicator
This is no one simple line on a chart. Some trading platforms list the indicator as a trend one. Others list it as an oscillator.
The truth is that it has a bit of both. Judging by the fact that the trading platforms apply it on the actual chart, it looks like a trend indicator.
If we consider the strong support and resistance levels at the cloud area, it looks like an oscillator, with overbought and oversold levels.
In any case, the Ichimoku indicator is a complex one. It has no less than five lines:
- The Tenkan line – this is the yellow-brown line on the chart below.
- The Kinjun line – the blue line from the same chart.
- The Chinkou line – the purple line.
- The Senkou A and Senkou B lines.
The last ones are the ones that give the cloud, or the Kumo, as it is also called. In fact, they are the edges of the cloud.
When Senkou A crosses above Senkou B, the Kumo turns bullish. Or, green.
When the opposite happens, the Kumo turns read, or bearish.
Trading with the Ichimoku
Trading with this indicator is straight forward. There are several steps to consider.
Firstly, check the cloud’s color. On a green color, traders want to buy. On red, they want to sell.
Hence, there’s always a bias regarding the next trade. In the example above, the bias is bullish.
Secondly, look to buy at support. Support is given by the cloud (when the price hits the cloud) or by the other elements (lines) that make the Ichimoku.
However, not all trends are the same. Some are stronger than the other, and, of course, trends reverse.
As such, look to take only the first trades. Or, the first touch of those elements.
Finally, the two entries are shown above. One time when the price hits the cloud, and another one when the dip hits the Kinjun and Tenkan lines.
As for the take profit, traders use Chinkou’s highest value. When this comes, they exit.
This is just one way to use this wonderful indicator. There are plenty other ones.
Some traders use the future support and resistance levels to forecast the shape of the future price action.
Others look at the moment the Tenkan and Kinjun lines cross. And so on.
In any case, this is one of the most powerful indicators the Japanese brought to the technical analysis branch. Westerners embraced it quickly.