Table of contents:
- 1 The technique of Ichimoku Kinko Hyo
- 1.1 The lines of Ichimoku Kinko-hyo
- 1.2 Basics of the Tenkan Sen and the Kijun Sen
- 1.3 Application of the “Tenkan Sen” and the “Kijun Sen
- 1.4 The interaction of the two Ichimoku Kinko-hyo lines
- 1.5 The cloud of Ichimoku Kinko-hyo, called “Kumo
- 1.6 Using the Kumo cloud of the Ichimoku Kinko-hyo
- 1.7 The space of the cumo cloud as a warning signal
- 1.8 The last element Chinkou Span – the difficult special case
- 1.9 Trading strategies with the Ichimoku Kinko-hyo
- 1.10 The Tenkan Kijun strategy in Ichimoku Kinko-hyo
- 1.11 The Kumo strategy in Ichimoku Kinko-hyo
- 1.12 The overall Ichimoku Kinko-hyo strategy
- 1.13 Conclusion to the Ichimoku Kinko-hyo
As the name easily reveals, Ichimoku comes from Asia, or more precisely from Japan. This may sound a bit exotic for some people and create reservations. However, one should be aware that one foundation of today’s technical analysis also comes from Japan and cannot be imagined without it: the candlesticks, simply called candles in this country. These have existed for well over a hundred years and only became known in the West at the beginning of the 1990s through Steve Nison’s book on “Technical Analysis with Candlesticks”.
Today the majority of all traders mainly use candlesticks, from retailers (private traders) to hedge funds. They are virtually indispensable for analytical trading and have become the standard. The Ichimoku will probably not take this position. However, it should make clear that the financial culture of the Asian region always produces methods that can be ahead of others. That is why it makes sense to look into the logic of this technical method of analysis.
Ichimoku was already developed during the Second World War by the Japanese journalist Goichi Hosada. Together with some students he worked on the development for about thirty years before he presented the indicator technology to the public in 1968. This is the name of the Ichimoku as a whole, actually Ichimoku Kinko-hyo, which translated means “everything at a glance”. In Japan, Ichimoku Kinko-hyo quickly gained great popularity and spread to the west of the financial market world. It is now used in CFD trading and stock trading, as well as in the commodity, precious metals, bond, futures and currency markets.
The technique of Ichimoku Kinko Hyo
Following the story of Ichimoku Kinko-hyo, one should know that this method of analysis refers to a time when the trading week had six days left with Saturday. Accordingly, the configurable values of the respective lines refer to this. Since the trading week today is only five days, many people assume that the values would have to be adjusted to this circumstance.
The still valid default settings of the lines of the original Ichimoku Kinko-hyo are a triple of 9 (Tenkan-sen), 26 (Kijun-sen) and 52 (Senkou Span B). Advocates of the 5-day values, however, modify these settings in 7, 22 and 44, but there is no empirical evidence yet that this significantly improves performance. Not even if one takes into account the fact that, for example, some futures markets or forex trading run almost 24 hours, while others, such as equity or spot trading, pause for a long time.
In my experience, the Ichimoku Kinko-hyo reacts slightly faster with the settings for the 5-day week, but also gives more false signals. However, for those who like to experiment, the indicator offers almost endless possibilities to tweak the settings in order to perhaps achieve the best results in different markets that have their own characteristic movement patterns.
The same applies to different time units in which one wants to trade. You can find a lot of information about this on the net, ranging from 6 – 12 – 24 for the hourly chart to 72 – 144 – 288 for 5-minute charts. To what extent such applications really make sense, I discuss below. If you want to use such settings, you should always keep in mind that backtests are of course an absolute must here.
The lines of Ichimoku Kinko-hyo
What distinguishes Ichimoku Kinko-hyo from all other indicators is its five lines. Each of these lines has its own meaning due to its calculation and generates in interaction with the other lines an interaction from which signals with different valences result.
As mentioned above, the number of lines and how they are displayed within a chart may cause confusion for the beginner. Therefore, for a better understanding of Ichimoku Kinko-hyo, one should divide the lines into three types:
a) the two lines of the moving average, which in principle can also be used separately as signal generators;
b) the edge lines of the so-called cloud called “Kumo”;
c) the Chikou Span, which is special and of more importance for some, and less for others.
Basics of the Tenkan Sen and the Kijun Sen
The lines of the Tenkan Sen and the Kijun Sen are nothing more than gliding averages and form a basis of the Ichimoku Kinko-hyo. The Tenkan Sen represents the faster average. It is calculated from the highest highs and lowest lows of the last nine periods (from the candlestick chart), divided by two:
- Highest high + Lowest low / 2 – from the last 9 periods
The Kijun Sen is the slower moving average and is considered a “confirmation line” that can also be used as a support or resistance line. Thus the Kijun Sen is always a line for stop-setting. It is calculated like the Tenkan Sen, but based on the past 26 periods:
Highest high + Lowest low / 2 – from the past 26 periods
Application of the “Tenkan Sen” and the “Kijun Sen
At first glance, the two averages seem simple in principle. However, they also provide valuable information and fulfil important functions. Therefore, if the tenkan Sen is pointing upwards, there is a corresponding upward trend. Conversely, there is a downward trend if the tenkan Sen is directed downwards. Similarly, the strength of the trend can be measured by the position of the average line. Because the further away it is from the “Kumo” cloud, the stronger the trend is.
Furthermore, the line functions as a small continuous support in the up-trend or as resistance in the down-trend. This can be easily seen on the chart and can often be used profitably in short-term trading, for example.
The most important function of the Tenkan Sen, however, arises in the interaction with the line of the slow average, the Kijun Sen. In general, the first thing to do is to trade long above the line and short below it. Furthermore, the Kijun Sen line is a clear indicator of resistance and support. It can therefore be used as a realistic level for setting a stop-loss, taking into account the market noise.
The interaction of the two Ichimoku Kinko-hyo lines
It becomes elementary, however, when the two lines cross each other. Usually the faster Tenkan does this. If it crosses the Kijun from bottom to top, a buy signal is generated. Vice versa, a sell-signal is generated when Tenkan crosses the Kijun-line from top to bottom. Incidentally, the crossing of both lines indicates the confirmation of a new trend. If Tenkan and Kijun lie on top of each other, one should refrain from trading as the situation is unclear.
However, not every crossing is a direct buy or sell signal. Decisive for the value of the signal is the dynamic of the intersection. The flatter it is, the less sustainable the signal is, while a steep intersection is a stronger signal. The fast Tenkan line should therefore intersect the slower Kijun line in as vertical a direction as possible. If it then turns back in the direction of the slower average, a further reversal of the trend can be assumed.
As such, Tenkan Sen and Kijun Sen can theoretically be used independently to generate signals. In practice, however, one would do well to see an intersection as the first signal that requires confirmation. This is where the Ichimoku Kinko-hyo shows its strengths compared to other indicators. Because apart from the two average lines the “Kumo”-cloud is the oftentimes so called “heart” of this indicator.
The cloud of Ichimoku Kinko-hyo, called “Kumo
At first, many people only perceive the kumo cloud of “Ichimoku Kinko-hyo” as a pure graphic surface in the chart. Yet, it also consists of two lines, whose interior is filled with two different colors. There is basically no upper or lower line, but only the so-called Senkou Span A and the Senkou Span B. Only the value of the latter can be configured in the settings of the Ichimoku Kinko-hyo.
The special thing about these two lines is that they again combine the values of the average lines shown above in different periods or project their isolated development into the future. Thus the Senkou Span A specifically records the values of the Tenkan and the Kijun and projects them for 26 periods in advance:
- Tenkan + Kijun / 2 – forms a limiting edge of the Kumo cloud;
The Senkou Span B, on the other hand, is an extension of the average lines to 52 periods and projects them for 26 periods in advance:
- Highest High + Lowest Low / 2 – from the past 52 periods, forms the opposite boundary edge of the kumo cloud.
Since the two lines overlap again and again, the space between them is called cloud or just “Kumo”. If now the A-line lies above the B-line, the Ichimoku Kinko-hyo attests a rising market and assigns the cloud a corresponding colour. If the B-line is above the A-line, a falling market can be assumed. Again, the Ichimoku Kinko-hyo assigns a corresponding color to the cloud. These colors can be customized just like the lines in the configuration settings of the indicator.
Using the Kumo cloud of the Ichimoku Kinko-hyo
As with the average lines, the cloud has several functions. The most noticeable one is certainly the projection into the future, because it shows the trader what the trend is about. Normally the A and B lines run relatively parallel during an intact trend. However, if a trend change is indicated, the lines approach each other and eventually cross. This crossing initially means at least a weakening of the trend, while a subsequent widening of the lines visualizes the trend break.
Many users also call this crossing Golden Cross and use it as an entry signal for a trade. However, I think this is too aggressive, and the Ichimoku Kinko-hyo provides enough additional information to assess the risk of a trade. These provide the Tenkan and Kijun line. As long as the two averages are above the Kumo cloud in the uptrend and below it in the downtrend, the present trend can still be considered intact. The intersection alone provides only an indication of a possibly upcoming trend change.
The space of the cumo cloud as a warning signal
The space of the kumo cloud is of great importance, because it represents a support and resistance area. The Senkou Span A and B lines that border it form the immediate price markers for resistance or support. It can be observed again and again that prices bounce off the first Senkou Span line of the kumo cloud. However, if the price falls into the cloud, this is a further indication of a trend change, while now the second Senkou Span line is considered the last resistance or support.
If the price breaks through this line at the closing price of the period and thus leaves the kumo cloud, the trend is not only considered reversed, but also provides an entry signal. This renewed entry signal should at best be confirmed by a dynamic crossing of the Tenkan line by the Kijun line. However, if the price remains in the area of the Kumo cloud for a longer period of time, the market is probably in a sideways phase and should not be traded.
The shape of the kumo cloud must also always be considered. If it is very voluminous, the trend is very strong and vice versa. At the same time, the course of the limiting Senkou Span B line gives an indication of the state of the trend. Thus, in the upward trend, the lower B-line should always form straight planes, which form stair-like ascending levels, while in the downward trend the planes form stair-like descending levels.
If the stair formation stops, this is an indication of a weakening trend, at the end of which a golden cross could be reached and a crossing of the two Senkou Span lines could occur.
The last element Chinkou Span – the difficult special case
The Chinkou Span line is sometimes somewhat controversial. Some use it vehemently and consider it the soul of Ichimoku Kinko-hyo, while others consider it superfluous and ignore it. Your task is simple. It basically just projects the current course back by 26 periods.
The purpose is to provide additional confirmation of an up or down trend in case the trader wants to open a position based on a signal. What matters is that the end of the Chinkou Span line, which reflects the current price, is above the price 26 periods earlier when there is a long signal. Conversely, if there is a short signal, the end of the line should be below the price 26 periods earlier. If this is not the case, traders who want to minimize risk will wait for further signals before opening a trade.
Trading strategies with the Ichimoku Kinko-hyo
The Ichimoku Kinko-hyo is one of the most complex indicators. Because of its many elements it can be used in many different ways. If you take the elements for themselves, different trading strategies can be created, which allow different trading approaches. These can be divided into three categories. The simplest strategy, which can be used with adjusted settings in almost any time unit, is probably the Tenkan-Kijun strategy.
The Tenkan Kijun strategy in Ichimoku Kinko-hyo
As we have already seen above, the two lines are calculated from averages of given periods. The Tenkan-Sen is a fast average, while the Kijun-Sen is the slower one. Buy signals are given when the Tenkan line crosses the Kijun line from bottom to top. For a sell signal, the Tenkan line must cross the Kijun line accordingly downwards. This crossing should always be dynamic. Subsequently, the Kijun line provides a realistic stop-loss mark.
This strategy completely hides both the Kumo cloud and the Chinkou Span line. It is therefore generally considered to be aggressive and, on its own, often gives false signals in the higher time units when the Kijun line is used as the ultimate stop-loss. It is true that these false signals also occur in the lower time units, such as the 5-minute chart. However, in such short time units, it is possible to react more quickly to the price development, and the position size and risk management are or should be adapted to such trades.
Those who like to experiment can test the settings of the two averages extensively here. In practice, however, it has been shown that the standard settings 9 and 26 also work best in the short-term time units. There is no empirical evidence for other settings that are permanently successful.
The Kumo strategy in Ichimoku Kinko-hyo
The Kumo strategy refers to the so-called Kumo breakout and is still one of the most well-known strategies today. As the name suggests, it depends on the price first passing through a cloud before finally breaking outside the cloud and at the closing price of a period. This represents a buy signal above the cumo cloud and a sell signal below the cumo cloud.
In both cases the Senkou-Span B-line can mark the stop-loss. However, the shape of the kumo cloud plays a major role here. It should be as distinct and broad as possible, thus primarily indicating a strong trend, but also a broad support or resistance range. If it is flat or thin, the trend is considered to be rather weak and susceptible to a return. In this case, it is better not to open a position.
The kumo breakout strategy can be used well in all time units if one is aware of certain characteristics. In terms of signalling, it is somewhat stronger than the Tenkan-Kijun strategy, but only works as long as there is a clear trend. In sideways phases it is hardly usable in time units below the 4-hour chart, as the risk of false signals increases significantly.
However, the good news is that breakouts in the lower time frames, especially on the 5-minute chart, are very clear and can be traded.
The overall Ichimoku Kinko-hyo strategy
While the two strategies mentioned above can certainly be used on their own, it should be remembered that they are only parts of an overall system. Therefore, the Ichimoku Kinko-hyo as a whole is also to be seen as a strategy. Thus, its meaning goes far beyond that of a mere indicator.
Because the signals of one strategy are in meaningful interaction with the other. This is to be understood in a way that one signal is confirmed by another. For example, if the tenkan crosses the Kijun-line dynamically from bottom to top, this first buy-signal must be confirmed by the price breaking through the cloud above it at the closing price. If this is the case, the position can be opened.
The position should then be secured by a stop loss using either the Kijun line, or the Senkou Span A or B line if the cloud at the bottom in this case indicates an intact trend. The cloud itself also defines the support area. The same applies in reverse for sell signals. Of course, the Kumo cloud, which is projected into the future, should always be taken into account here, as it provides information about the possible development of the present trend.
Traders looking for maximum possible security should also take a look at the Chinkou Span line. Its end should be above the closing price of the 26-period older candle when a buy signal is given and below it when a sell signal is given. If this is the case, the Chinkou Span can confirm the current up- or downward trend once again and thus amplify the signal.
Conclusion to the Ichimoku Kinko-hyo
Ichimoku Kinko-hyo is without a doubt a complex system that you have to get used to in order to understand it and apply it correctly. This makes it different from almost all other indicators. What makes it different is the interaction of several elements and the orderly presentation of these elements in the chart, even if they seem confusing to the beginner at first. The advantages are obvious.
Signals that occur when observing moving averages can also be reversed quickly. The strength of the Ichimoku Kinko-hyo only becomes apparent through the possibility of confirming them by means of the Kumo cloud. Moreover, the kumo cloud itself is already an element for trend recognition.
In this respect, one has to consider the Ichimoku Kinko-hyo not only as an indicator, but rather as an effective trend-following system, which becomes a complex trading system with its signalling.
Disadvantages of the Ichimoku Kinko-hyo
The often-discussed disadvantage of Ichimoku Kinko-hyo is, apart from the elaborate graphical depiction, a supposed slowness. However, it’s all about the perspective.
Of course, only the moving averages can be used to achieve higher profits, if their signals are used without waiting for a confirmation by means of the kumo cloud. But this undoubtedly also increases the risk that the position will be stopped out too early and, at worst, in a loss. Those who wait for confirmation of the signal may have to accept lower profits, but are likely to trade more sustainably.
Finally, the user should ask himself in which time unit he wants to use the Ichimoku Kinko-hyo. In practice, the trend following system on the 4-hour chart and above is relatively stable. However, with regard to the stop-loss, a healthy risk management is required here. Many still use it successfully in the 1-hour chart.
In smaller time units, the danger of sideways phases or false signals detected too late is very high. Although the Ichimoku Kinko-hyo can also be used in the 5-minute chart, the management of an open position should be based on the course of the Senkou Span B line, depending on risk affinity. When in doubt, it is certainly not wrong to make exits discretionary or according to other criteria.
In any case, you should not do without the extensive test in a demo account before you cut your pieces out of the stock market cake with the Ichimoku Kinko-hyo.