TRADERSstrategies

A Different Perspective on the Markets

Trading the Ichimoku Way

How can Ichimoku charts form part of your strategy analysis? These Japanese charts take a different perspective on the markets when compared to your ordinary
bar, candle and line charts with technical indicators plotted underneath. They help to visualise the constant change in the trend of a chart. The price movement
each day will impact the overall strength of the trend and momentum on the chart and the clouds will capture this. Every trend moves in waves with the cycles
creating retracements as part of a natural process, which affects the momentum in either a positive or negative way. This is a key feature which Ichimoku charting
tries to capture visually.

o Think back in time. When you used your first candlestick
chart, it was probably a small revelation to see how the
patterns that show up everywhere on the charts could
really help to identify turning points and reversal signals.
F1) The Ichimoku Kinko Hyo Chart
Ichimoku works in the same way helping to identify changes
in the trend and momentum giving you a visually superior
idea of where the potential support and resistance areas are
on the chart by analysing the trend and momentum. The
second concept of Ichimoku is to understand that the chart
is forward projecting and places lines and formations ahead
of the price. This is a great variation from using conventional
indicators such as MACD to generate buy and sell signals in a
retrospective manner. It is literally, a forward thinking chart.

Evolving from Moving Average Lines

The Ichimoku Kinko Hyo chart was developed before World
War II by Goichi Hosoda, a Tokyo newspaper writer. Although
this indicator was developed over 70 years ago, its popularity
in the West really only started in the 1990s. The chart will
display dynamically four features (i) the strength of trend, (ii)
the trend direction, (iii) support and (iv) resistance areas. The
word Ichimoku can be translated as one glance, and the
full name can be translated as one glance cloud equilibrium
chart.

Understanding the Basics

What type of indicator is this? It is a trend-following indicator
and therefore all the caveats apply when trying to use this
Figure 1 shows the three components of the Ichimoku chart: a basic candlestick chart, two moving averages called in markets where data is sparse or in non-trending markets.
Tenkan Sen and Kinjun Sen, and two clouds called Senkou Leading Span 1 and Senkou Leading Span 2. Traditionally, the daily mid-prices are used instead of closing
Source: www.sharescope.co.uk. prices.

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This can help to give a clearer picture especially in F2) Anglo American PLC
markets where the closing prices are artificially inflated with
a flurry of buy orders seconds before the end of the day. The
chart is made up of three major components (see Figure 1).

1. A basic candlestick chart.

2. Two moving averages are then plotted, the Tenkan Sen
and Kinjun Sen. These are used as a moving average
crossover to generate buy and sell signals. This is similar
to the dead cross and golden cross in the more
traditional 50 and 200-day moving average crossover
systems.
3. Next we form the clouds. Two further lines are plotted
called the Senkou Leading Span 1, which is a derivative
of the Tenkan and Kinjun Sens and Senkou Leading
Span 2, which is a midpoint base line derived from the
high and low over a defined period. By filling in the
gap between these two lines we form the Ichimoku
cloud component, representing special support and Since the Tenkan Sen (red line) crosses the Kinjun Sen (blue line) from below, there is a buy signal (yellow circle).
resistance areas. Source: www.sharescope.co.uk.

Constructing the Chart for the Moving Averages

(See Figure 1): Turning Theory into Practice
Tenkan Sen or Turning Line This is calculated by taking It may sound somewhat complex, but using the Ichimoku for
the (Highest High + Lowest Low) / 2 for the past nine daily trading is fairly simple after understanding a few basic
periods. principles. Lets look at an example to break the technique
Kinjun Sen or Standard Line This is calculated by taking down into a simple usable trading strategy.
the (Highest High + Lowest Low) / 2 for the past 26
periods. 1. The chart generates a buy signal when the Tenkan
Sen (red line) crosses the Kinjun Sen (blue line) from
For the two main lines that need to be computed and below and a sell signal is generated when the Tenkan
displayed for the cloud to be seen: crosses the Kinjun from above. Look at the buy signal
Senkou Leading Span 1 = (Standard Line + Turning Line) / 2, on Anglo American PLC in the yellow circle (see
plotted 26 periods ahead of the current period. Figure 2).
Senkou Leading Span 2 = (Highest High + Lowest
Low) / 2, for the past 52 periods, plotted 26 periods
ahead of the current period. F3) Candlestick Chart of British Land PLC
Forward Thinking Possibilities
The chart is based on the basic principles of support and
resistance and makes the assumption that past support once
established will continue to act as support and only change
to resistance once broken. Because the leading spans are
plotted 26 periods ahead of the current bar, better analysis
of support and resistance zones is possible and the clouds
dynamically adapt in width providing further information to
determine their strength. This can help to reduce the risk of
trading false breakouts.

T1) Formulas
Kinjun Sen = (HH (26) + LL (26)) / 2
Tenkan Sen = (HH (9) + LL (9)) / 2
Senkou Span 1 = (Kinjun Sen + Tenkan Sen) / 2, -25)
The 6-month downtrend resistance line is broken at the beginning of September 2007 so we have a classical
Senkou Span 2 = (HH (52) + LL (52) / 2, -25)
breakout buy signal at 13.10 (red arrow).
Chikou Span = C [-25] Source: www.sharescope.co.uk.

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F4) Ichimoku Chart of British Land PLC 2. Lets now look at the cloud, known as the Kumo, which is
the area plotted between the Senkou Span A and B. This
is highlighted in blue and pink in Figure 2. This support
and resistance band is wider and more useful when
compared to a single trend line. The thicker the cloud,
the greater the volatility that has been in place in the
preceding price movements. Note that the price gapped
over the cloud on the 17th of September.

Using Ichimoku to Enhance

Simple Trading Strategies
Lets look at a comparative example where Ichimoku can
take advantage of its ability to factor in volatility into its
support and resistance bands. In Figure 3 we can see a
confirmed downtrend and trend line resistance area above
the price highlighted by the red resistance line. A classic
breakout buy signal is given at 13.10 on a chart where a
6-month downtrend resistance line is broken on the daily
chart of British Land Plc at the beginning of September 2007
The Ichimoku chart generated a buy signal when the Tenkan Sen (red line) crossed the Kinjun Sen (blue line) at the (red arrow). Now if we look at the Ichimoku chart (Figure 4) we
end of August 2007. However, there is a band of resistance just above this area in the form of a cloud. can see a buy signal was given when the Tenkan crossed the
Source: www.sharescope.co.uk. Kinjun (red line crosses the blue line) at the end of August 2007.
In this case there is a band of resistance just above this area
in the form of a cloud. Here the chart suggests only initiating
F5) Ichimoku Weekly Chart long positions when the price pattern breaks out above the
cloud area at 13.30 level. This would act as an additional filter
to help prevent trading a false breakout. Notice also in Figure
4 the behaviour of the Kinjun sen (blue line), which has acted
as a resistance level from May until August.

Getting an Edge
Ichimoku charts have historically been used in the daily
time frame, although using them in both the weekly and
shorter-term time frames can give added value. The time
periods used for calculating the Tenkan (nine working days
in 1.5 weeks) and Kinjun (26 working days in one month) are
derived from the number of trading days in Japan at the time
of its creation. The working week was six days in Japan at the
time and it can be argued that a modification to change this
to a 5-day working week as we currently have in the western
system would yield better results and improve the system.
As with all technical analysis, feel free to experiment to see
We added Chikou Span, a lagging span indicator (dotted green line). Here you can see how the price trends above what works best for you.
and below the clouds.
Source: www.sharescope.co.uk. Strategy Timing for Ichimoku Trading
By further analysing a longer-term 2-year weekly Ichimoku
chart (see Figure 5) we can put this recent downward move
into perspective in the cycle of ups and downs that this stock
exhibits.
We can clearly see how the price trends above and below
the clouds. This is a strongly trending stock and this means
we can assume that Ichimoku will work well. On this chart
Rakesh Shah we have added Chikou Span (a lagging span indicator). This
is the current price shifted 26 periods behind shown as the
Rakesh Shah, a professional trader, specialises in Advanced dotted green line. Chikou Span gives additional information
Trading Strategies after working as an investment banker from by comparing it with the current price. We can use it to find
1995 in London and on Wall Street. support and resistance with the clouds, Tenkan and Kinjun
lines.

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Ichimoku in a Trending System F6) Ichimoku 6-month Chart for WPP

1. Trending. Here we can see how Ichimoku works best in a
strongly trending environment. Avoid using it in choppy
or non-trending markets.
2. Easily Recognisable Pattern. In the 6-month chart (see
Figure 6) of WPP Group PLC, we can see that resistance
offered by the cloud has contained the price. This has
given a number of low-risk trading opportunities in
which to enter into a short position with a relatively tight
stop loss.
3. Select Only The Best When Presented with Multiple
Signals. We can see a cluster of signals on the left of the
chart in the blue cloud area in May (shown with red down
arrows on the chart). We can also see a number of signals
further along the chart in July and August.
4. Entry Signal. Here the strategy would be to initiate a
short position whenever the price touched the cloud
with a candlestick reversal pattern and place a stop loss
above the cloud.
5. Simple Stop Loss Points. A move above the cloud On the left side, there are several signals in the blue cloud area in May (red arrows). Further signals follow in July
will signal that resistance has given way and the trade and August. When the price touches the cloud with a candlestick reversal pattern, we can open a short position
is invalidated at which point the stop loss should be and place a stop loss above the cloud.
activated. Using this system we have a fairly successful Source: www.sharescope.co.uk.

trigger set up on this stock, with an easy-to-place stop.

6. Money and Risk Management. Have a simple money
and risk management plan in place before you trade.
Adhere to strictly defined rules to control the position.
Once you see the price break through the cloud, we have our
first signal that we have a changed trend and it is at this point
that we will begin to see favourable set-ups. Remember
the price must break through the cloud before you will
see the favourable set-ups above. Ichimoku combined
with candlestick patterns to signal reversals back into the
trend when used in strongly trending charts can yield
excellent results. The system described above can be used
in a fairly manual fashion and will require a degree of visual
interpretation of the chart. Over a longer period of time
there is always the possibility of a number of trades that may
be stopped out when the trend is coming to an end and the
market begins to consolidate. Money and risk management
will be key at these points.
Although a little daunting at first, in trending markets,
Ichimoku can give you trading signals with a win-loss
ratio that is above 50 percent and the price movements
are fairly strong after the entry signals due to the nature
of the support and resistance characteristics. Ichimoku
offers unique trading signals and must be used within the
primary context of a strong money and risk management
plan. n

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