Technical Analysis (Part 15): Direct Price Analysis (DPA): Ichimoku

Part 14 showed us how useful and effective Pivots could be, especially for intraday trading. Part 15 introduces us to a very individual concept in technical analysis. Ichimoku is a unique trading tool for analysing any asset in any timeframe. To the outside observer, at first glance it looks a complete mess. Untangle it though and you have a straightforward and very powerful all round trading system that can seriously boost your trading results.

This blog presents a simple overview of this system, building up the tools of Ichimoku using the S&P 500 Stock Indices as the base example, hopefully giving you an initial starting point on your journey into a unique part of technical analysis.

'One look'

Ichimoku, otherwise known as Ichimoku Kinko Hyu, was developed by a Japanese journalist Goichi Hosoda and published in his book in 1969. It means ‘one look’. It is a collection of technical analytical techniques to determine:

• The trend

• Momentum

• Support and resistance

• Trading signals

• Entry and exit points

Example: Typical Ichimoku set up on S&P500 Index (Charts: Stockopedia)

Ichimoku: a one stop trading shop!

The basic components of Ichimoku

It is made up of 5 key parts. 4 of the 5 are based on the average high / low over a given period.

1. Tenkan-sen (Conversion Line): (9-period high + 9-period low)/2))

2. Kijun-sen (Base Line): (26-period high + 26-period low)/2))

3. Senkou Span A (Leading Span A): (Conversion Line + Base Line)/2))

4. Senkou Span B (Leading Span B): (52-period high + 52-period low)/2))

5. Chikou Span (Lagging Span): Close plotted 26 days in the past

The inputs above are the original default settings.  However, there is nothing to stop you changing and adapting a different set up.

S&P500 Index (Charts: TradingView) with Japanese labels:

Ichimoku rules: The cloud

Senkou Span A and B form the shaded area known as the cloud, or to give its official name, the Kumo. The cloud changes trend direction when these two lines cross. In the example, here for clarity, green signifies bullishness and red bearishness (standard default colours in most chart packages). Again, there are no rules to say what colours you need to use. The cloud can be great for highlighting potential support and resistance levels.
There are two ways to identify the overall trend using the Cloud.

1. The trend is up when prices are above the Cloud, down when prices are below the Cloud and flat when prices are in the Cloud.

2. The uptrend is stronger when the Leading Span A line is rising and above the Leading Span B line. This situation produces a Green Cloud. Vice versa: a downtrend is stronger when the Leading Span A line is falling and below the Leading Span B  line. This situation produces a Red Cloud.

The Cloud is also shifted forward 26 days, so as to provide a view on future support or resistance.

S&P 500 Index (Charts: TradingView) Ichimoku set up with only the Kumo displayed:

Ichimoku rules: The Conversion Line and the Base Line

These are used to identify faster, and more frequent, signals. They are very similar to the Western moving average crossover system. Trading signals occur when the two cross:

• Conversion line > Base line = Bullish

• Conversion line < Base line = Bearish

Remember: bullish signals are potentially stronger when prices are above the cloud and the cloud is green.
Bearish signals are potentially weaker when prices are below the cloud and the cloud is red.

S&P500 Index (Charts: TradingView) Ichimoku set up with close up of conversion lines crossing:

Ichimoku rules: The Chikou Span

This can be used to pick out bearish and bullish signals. It is therefore perceived as a mirror of price action in a typical trading period. To use it, you must look for its position in relation to the position of the price action, traced back to 26 candles previously.

• If the Chikou span is above the price action, then this is a bullish signal.

• If it's below the price action, then the sentiment in the market is bearish.

• If the Chikou is found where the candlesticks are, then this equates to possible consolidation.

Its primary uses are for confirming support and resistance and pinpointing breakouts through the cloud.

S&P500 Index (Charts: TradingView) Ichimoku set up with Chikou Span:

Taking it further

Why not add a Western indicator or even other Japanese methods, to give further transparency around timing, entry and exit to build an even more robust trading strategy? In the example below, a stochastic and RSI indicator has been added to a Heikin Ashi S&P500 Daily Ichimoku set up:

Example: S&P500 Index (Charts: Stockopedia) set up with Heikin Ashi chart with Stochastic and RSI indicators:

Further reading and learning

If you are interested in learning more about trends, support & resistance then the following reading may help:

• Ichimoku Charts: An Introduction to Ichimoku Kinko Clouds, Nicole Elliott, (Harriman Trading), 1 Feb 2007.

• Ichimoku Charts: Advanced Candlestick Analysis Using Cloud Charts, Nicole Elliott, (Harriman Trading) 2010.

Conclusion

Once the components to this system are understood, then it becomes quite apparent that this is indeed a very useful trading and risk management tool. Your options are endless with Ichimoku and this is what makes it a fascinating and exciting technical analysis tool. Enjoy!

Next time: Technical Analysis (Part 16): Price Confirmation Tools (PCT): Trend & Momentum