Ichimoku Cloud

Published on :

21 Aug, 2024

Blog Author :

Edited by :

Reviewed by :

Ichimoku Cloud is a technical analysis tool used to analyze financial markets. It comprises five lines plotted on a chart to provide a comprehensive view of support, resistance, momentum, and trend direction. The area between the two lines create the 'cloud,' its purpose is to indicate potential support and resistance levels.

Traders use the Ichimoku Cloud to identify potential entry and exit points, and thus is very important as it confirms trend direction and momentum. In addition, the tool is versatile and can be used on any financial instrument and time frame, making it a valuable addition to any trader's toolbox.

What Is Ichimoku Cloud?

The Ichimoku Cloud is a popular technical analysis tool using five lines derived from historical data to provide a comprehensive market view.
The tool can identify trend direction, support and resistance levels, and potential entry and exit points.
The price position relative to the cloud indicates the trend direction, with a price above the cloud suggesting a bullish trend and a price below the cloud suggesting a bearish trend.
The cloud can serve as dynamic support and resistance levels. Entry and exit points can be found when the price crosses the Tenkan-sen or Kijun-sen lines, and the cloud can be used as a guide for stop-loss placement.

Ichimoku Cloud Strategy Explained

Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a technical analysis tool used to analyze financial markets. Japanese journalist Goichi Hosoda developed it in the late 1930s. It has gained popularity in recent years due to its ability to provide multiple types of analysis in one chart.

The Ichimoku Cloud comprises five lines plotted on a chart to provide a comprehensive view of support, resistance, momentum, and trend direction. These lines are:

Tenkan-sen (Conversion Line)
Kijun-sen (Base Line)
Senkou Span A (Leading Span A)
Senkou Span B (Leading Span B)
Chikou Span (Lagging Span)

The area between Senkou Span A and Senkou Span B is shaded to create the 'cloud,' which indicates potential support and resistance levels. Day traders use the Ichimoku Cloud to identify potential entry and exit points and confirm trend direction and momentum.

Overall, the Ichimoku Cloud is a versatile tool that can be used on any financial instrument and time frame, making it a valuable addition to any trader's toolbox.

How To Use?

Let us look at the To use the Bitcoin/US Dollar Ichimoku Cloud chart and a few steps to understand how traders can utilize this technical analysis tool to achieve their trading objective.

Source

#1 - Identify The Trend Direction

The trend in the above chart can be identified by observing the position of price in relation to the cloud. If the price is above the cloud, the trend is considered bullish. That said, if it is below the cloud, ike it was in the month of March, the trend is considered bearish. The chart shows that from September 30, prices were above the blue cloud, thus representing a bullish trend in the market.

#2 - Confirm Trend Direction With Chikou Span

The Chikou Span is the lagging line that indicates the current price relative to past prices. A bullish trend is confirmed when the Chikou Span is above the price, and a bearish trend is confirmed below the price.

#3 - Look For Entry And Exit Points

Traders look for potential entry points when the price crosses the Tenkan-sen (conversion) or Kijun-sen (base) lines, and they look for exit points when the price approaches the cloud or the opposite Senkou Span. Note that in the above chart, the base line and the conversion line are purple and orange, respectively.

#4 - Determine Support And Resistance Levels

The cloud serves as a dynamic support and resistance level. When the price is above the cloud, the upper edge of the cloud becomes the first support level, and the lower edge becomes the second support level. Conversely, when the price is below the cloud, the lower edge becomes the first resistance level, and the upper edge becomes the second. One can observe in the chart that the upper edge of the blue cloud denotes the support level. Similarly, the lower edge of the red cloud marks the resistance.

People can utilize similar price charts on TradingView to understand how to use this tool better.

#5 - Use Other Indicators For Confirmation

Traders can use technical indicators like volume or oscillators to confirm their analysis.

Overall, the Ichimoku Cloud is a versatile tool that provides a holistic view of the market and can be used in various ways to identify potential trading opportunities. However, it is important to remember that no indicator is infallible, and traders should use multiple tools and techniques to increase the probability of success.

Formula

The Ichimoku Cloud is based on five lines, each with its formula:

Tenkan-sen (Conversion Line): (9-period high + 9-period low) / 2
Kijun-sen (Base Line): (26-period high + 26-period low) / 2
Senkou Span A (Leading Span A): (Conversion Line + Base Line) / 2, plotted 26 periods ahead
Senkou Span B (Leading Span B): (52-period high + 52-period low) / 2, plotted 26 periods ahead
Chikou Span (Lagging Span): Current closing price, plotted 26 periods behind

The Ichimoku Cloud is created by plotting Senkou Span A and Senkou Span B and then shading the area between them.

Traders use the values of these lines to analyze the market and identify potential trading opportunities. For example, when the Tenkan-sen crosses above the Kijun-sen, it is considered a bullish signal, while a cross below is considered bearish. The price position relative to the cloud and the Chikou Span are also used to confirm the trend and identify support and resistance levels.

It's important to note that the Ichimoku Cloud is a complex tool and requires a good understanding of its components and their interactions. Therefore, traders should spend time studying and practicing it before incorporating it into their trading strategies.

Examples

Let us look at the following examples to understand the concept better.

Example #1

Suppose an analyst is analyzing the daily chart of a stock to identify potential entry and exit points. Then, the Ichimoku Cloud can be applied to follow the steps outlined earlier:

Identify the trend direction: The price position relative to the cloud indicates the trend direction. If the price is above the cloud, it suggests a bullish trend; if it is below the cloud, it suggests a bearish trend.
Confirm trend direction with Chikou Span: The Chikou Span, which is the lagging line that indicates the current price relative to past prices, can confirm the trend direction. A bullish trend is confirmed when the Chikou Span is above the price, and a bearish trend is confirmed below the price.
Look for entry and exit points: Potential entry points can be found when the price crosses the Tenkan-sen or Kijun-sen lines. For example, if the price crosses above the Tenkan-sen line, currently at $100, it could be a potential entry point to place a buy order. Exit points can be found when the price approaches the cloud or the opposite Senkou Span.
Determine support and resistance levels: The cloud serves as a dynamic support and resistance level. When the price is above the cloud, the upper edge of the cloud becomes the first support level, and the lower edge becomes the second support level. Conversely, when the price is below the cloud, the lower edge becomes the first resistance level, and the upper edge becomes the second.
Use other indicators for confirmation: Other technical indicators, such as volume or oscillators, can be used to confirm the analysis.

Overall, the Ichimoku Cloud can provide a comprehensive view of the market and assist traders in identifying potential trading opportunities.

Example #2

Suppose a trader is analyzing the daily chart of a cryptocurrency to identify potential trading opportunities. The trader can use the Ichimoku Cloud to identify trend direction, support and resistance levels, and potential entry and exit points.

The Ichimoku Cloud can provide a comprehensive market view, allowing the trader to determine if the cryptocurrency is experiencing a bullish or bearish trend. If the price is above the cloud, it suggests a bullish trend. Whereas if it is below the cloud, it suggests a bearish trend.

In addition, the cloud can serve as dynamic support and resistance levels. When the price is above the cloud, the upper edge of the cloud becomes the first support level. Thenafter, the lower edge becomes the second support level. Conversely, the lower edge becomes the first resistance level when the price is below the cloud. After that, the upper edge becomes the second.

Potential entry and exit points can be found when the price crosses the Tenkan-sen or Kijun-sen lines. For example, if the price crosses above the Tenkan-sen line, currently $50, it could be a potential entry point to place a buy order. Exit points can be found when the price approaches the cloud or the opposite Senkou Span.

The trader can better understand the market conditions and make more informed trading decisions using the Ichimoku Cloud.

Ichimoku Cloud vs Bollinger Bands

Lets us see the difference between them in the following table:

Criteria	Ichimoku Cloud	Bollinger Bands
Calculation	Uses five lines derived from historical data	Uses two lines based on moving averages
Primary use	Trend identification and support/resistance	Volatility measurement and price extremes
Cloud interpretation	Price and trend above/below the cloud	Price and trend above/below bands
Trading signals	Crossovers, Kumo breaks, Chikou confirmation	Band squeezes, breakout/bounces from bands
Timeframe	Typically used on longer timeframes	It can be used on any timeframe
Complexity	Relatively complex, requiring study	Relatively simple and intuitive
Limitations	May lag in identifying trend changes	May generate false signals in range-bound markets

Frequently Asked Questions (FAQs)

Does Ichimoku cloud work?

The effectiveness of Ichimoku Cloud depends on the trader's skill and experience in using it. Nevertheless, it can be a useful tool for identifying trends and potential reversal points. Still, like any other technical indicator, it should not be used in isolation and should be complemented with fundamental analysis and risk management strategies.

How to read Ichimoku cloud?

To read Ichimoku Cloud, traders should first identify the location of the price of the cloud, which represents support and resistance levels. To determine the trend direction and momentum, they can then analyze the interaction between the five lines, including the conversion line, baseline, leading spans A and B, and lagging line. Traders can also look for signals such as the cross of the conversion and base lines or the lagging line's position concerning the cloud to identify potential entry and exit points.

How accurate is Ichimoku cloud?

The accuracy of Ichimoku Cloud varies depending on the market conditions, timeframe, and the trader's experience and skill in using it. While it can be useful in identifying trends and potential reversal points, it should not be relied on as the basis for making trading decisions. Instead, it should be combined with other indicators and analysis techniques to increase the likelihood of success.