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Trading with Clouds

Trading with Clouds
The Art of Ichimoku
By James Stanley Trading Coach DailyFX EDU instructor@dailyfx.com

“This information is provided to you for educational purposes only. This article does not suggest that you will experience similar profitable trades as the ones illustrated. Currency trading involves significant risk of loss.”

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Trading with Clouds

Origins

The fact that I can be trading at my home in Dallas, TX – where I can see, interpret, and act on the same signal that a trader from Shanghai, or Sydney had also identified - plays directly to the self-fulfilling prophecy of Technical Analysis. It’s almost as if it’s a language that, once learned, can whisper potential trade ideas in the trader’s ear. However – in practice – traders will often learn that the benefits of Technical Analysis aren’t in the ‘secret messages,’ that may or may not exist in markets; but the fact that it can help point to potential opportunities. Many traders find a combination of indicators that they feel really strongly about; spend hours upon hours practicing, and manually back-testing (testing the way that the strategy would have worked on charts that had already taken place) to ensure they can get the advantage they are looking for. Even then – principals of trade, risk, and money management are of the upmost importance. Most traders will find that negligence in any of these elements is akin to stuffing your money down a garbage disposal, even if trading with a strong technical strategy. A system that has recently gained popularity in the United States - and has the ‘pizzazz,’ of potential for being a self-fulfilling prophecy; while at the same time offering a strong technical infrastructure rooted on sound fundamental trading theory is Ichimoku (pronounced “Each-E-Mo-Ku”). Ichimoku is a trading system that was originally developed by Japanese journalist Goichi Hosada as he was looking to develop ‘The Ultimate Indicator,’ that could provide a multitude of analysis with a very quick glance. As a matter of fact, the term ‘Ichimoku,’ literally means ‘one glance,’ in Japanese. Ichimoku is considered to be a self-contained system in the fact that no additional indicators are necessary – everything is included that most traders will need to make trading decisions. Ichimoku is widely traded and followed throughout Japanese trading rooms – lending many to the idea that the unique ways of identifying support and resistance can make the system more compelling for Yen pairs such as GBP/JPY, EUR/JPY, and USD/JPY. There are quite a few components of Ichimoku – and it can make a chart look quite busy. Let’s start learning about this indicator by going right for the core of what makes Ichimoku tick.

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Trading with Clouds

Trigger the Base-Line At the very center of Ichimoku are the Tenkan-Sen and Kijun-Sen lines (referred hereon-out as Tenkan and Kijun respectively.) These two lines are the center of the Ichimoku system – and can be looked at as the ‘trigger,’ that denotes bullishness or bearishness. Tenkan and Kijun are really just moving averages. They differ slightly from standard moving averages in that they consider the ‘Average price,’ of each candle versus only the closing price (such as a simple or exponential moving average generally will). This causes the line to appear jagged (as opposed to the smoothing effect of a Moving Average calculated on close.) Tenkan is commonly the first input that the trader sees when applying Ichimoku to a chart. This is a 9 period Moving Average, and we can consider this the TRIGGER LINE of the system – as this is where all of the action behind Ichimoku is taking place. I make this line Lime Green when applying Ichimoku – so that it stands out and is very clear when a crossover takes place. Kijun is commonly the second input that is used – and this is a 26 period Moving Average (also exponential, calculated on average price). We can consider this as the BASE LINE.

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When the trigger crosses down. and through the base line – this can be looked at as a bearish signal. Page 4 .4 Trading with Clouds When the trigger line crosses up and over the base line – this can be considered a bullish signal.

’ which each crossover signal can be interpreted with. For right now – it is important to become familiar with the Trigger/Base Line Crossover. our charts should look roughly similar to what you see below: Now that we have Ichimoku completely applied to our charts – we can notice the power of the Trigger Line/Base Line crossover.’ line for Tenkan. While learning the Trigger/Base Line crossover. I will be using a ‘Green. lets apply it on the chart and manually back-test a few trades to get comfortable with the way that this works. Page 5 . it may help to arrange the Ichimoku indicator in an easy-to-read manner so that crossover is very clearly printed on the chart. If you’re not comfortable with this crossover yet.’ line for Kijun.5 Trading with Clouds The rest of the indicators within Ichimoku can help by telling us the ‘strength. Once completed. and a ‘Blue. For the remainder of this article.

We can keep going forward until we see a Trigger Line/Base Line Crossover. you can hit the ‘lock view.’ button on the toolbar (picture below).’ on our keyboards. We can manually back-test this crossover very simplistically on the Trading Station 2/Marketscope platform. This will allow the chart to stay on the time period you scrolled to when a new candle forms (rather than auto-scrolling to the new candle). Each time a crossover takes place – make note (either by writing down.6 Trading with Clouds While getting started with this system – let’s ignore everything on the chart other than the Trigger and the Base Line. or just noting mentally) and go further forward in time – watching how a hypothetical signal would have played out. Page 6 . Marketscope will automatically pull data from FXCM servers to fill in the appropriate pricing data. After you’ve gone far enough back. We can do this by simply clicking on the ‘Forward-Arrow. This will cause Marketscope to go forward one candle at a time on the chart. Scroll back in time by clicking and dragging to a previous period on the chart. Now that we are back in time – we can begin testing the Trigger Line/Base Line crossover.

I’ve highlighted the portion of the chart in which the Trigger Line is crossing over the Base Line – indicating the bullishness that may be entering into the pair.’ of the keyboard – watching the way that this hypothetical BUY would have worked out. We can then go forward in time by clicking on the ‘Forward-Arrow. Page 7 .7 Trading with Clouds For example – notice on the below chart that we have a Bullish Crossover taking place on on GBP/JPY.

50 was hit.000+ pip run on the GBP/JPY currency pair. Page 8 . and through the Base Line) took place shortly after the high around 162. We can now chart this SELL to see the way that it would have hypothetically worked out.8 Trading with Clouds After testing the way that this BUY entry would have played out – we see that the Bullish crossover of the Trigger Line over the Base Line immediately preceded a 1. We can then move onto the next crossover – which if you look at the chart above – will notice that the bearish crossover (Trigger Line fell down.

and comfort with this signal is of the upmost importance when trading Ichimoku. Notice that this entry would not have been as profitable as the previous bullish entry that we had taken – but after the signal took place – GBP/JPY went down over 700 pips. These are two of the most important elements of Ichimoku – and are the very core of the system.” Page 9 . If you have a difficult time remembering which line is which. Manually back-test until you feel comfortable with the Trigger Line/Base Line crossover. try to think of it as “Tenkan = Trigger. and Base Line = Blue.9 Trading with Clouds In the chart below – I’ve highlighted this SELL as the Trigger Line has crossed down and through the Base Line. The goal of manually back-testing these entries is so that we can internalize what happens when the Trigger Line crosses the Base Line. Everything else in Ichimoku can help us interpret these BUY and SELL signals – indicating how strong they may be.

One of the more important tasks that Kumo can help traders with lies in its ability to denote the trend of the currency pair. Page 10 . By default – Marketscope will print Kumo as BLUE during up-trending markets.’ in Japanese. Kumo actually just consists of two lines. making higher highs and higher lows. The area in between the two lines is shaded and it’s considered to be a moving range of support during uptrends. It’s constantly changing – in area and in width. and resistance during downtrends.’ or called ‘Kumo. It’s one of the areas of this indicator that makes the field of study so interesting. sitting underneath price as the currency pair trades higher. When a pair is trending up. Many traders will look to Kumo when setting stops on trades that were initiated by the Trigger/Base Line Crossover.10 Trading with Clouds The Cloud The part of Ichimoku that just absolutely jumps out at us when we apply it to our charts is the area known as ‘The Cloud. Kumo will function as support.

These periods will show Kumo printed as RED on the chart by default (please see below).11 Trading with Clouds And when a pair is trending down. One of the more unique aspects about Kumo is that it’s built for 26 periods in advance. However – keep in mind that this has absolutely no forecasting value whatsoever. If you observe current price on any chart in Marketscope while Ichimoku is applied you will notice that for 26 periods ahead – Kumo is already plotted and waiting for price. Kumo will function as resistance. making lower highs and lower lows. residing above price as the currency pair heads lower. Page 11 .

traders will notice its location in regards to Kumo and grade the strength of the signal accordingly. all of which are circled in RED. On the GBP/USD chart below – there are 3 BULLISH crossovers taking place.’ of the Trigger/Base Line crossover. When this crossover occurs. Let’s walk through an example together. One of the more valuable functions of Kumo is its ability to show traders the potential ‘strength. Page 12 . Let’s walk through each of the signals to see the way that traders would generally interpret these crossovers.12 Trading with Clouds How to Interpret Kumo Now that we know what Kumo is – let’s discuss how traders are using it.

13 Trading with Clouds During BULL CROSS 1 – notice that both price and the BULLISH crossover are below Kumo. but reversals will not always take place. Page 13 . If the reversal does take place. When this crossover takes place. the potential reward could be handsome. or if the bearish trend is going to prevail. For this reason – traders will often consider this to be a weak signal. Observance of risk by setting a stop is extremely important for these signals. it is at the end of a downtrend that was previously bearish. Traders are unsure as to whether the trend is going to change to the upside.

14 Trading with Clouds During the BULL CROSS 2 – The crossover and price are residing in Kumo as the Trigger crosses the Base Line. Traders will generally consider these Trigger/Base crossovers taking place in between Kumo to be of ‘moderate. Page 14 .’ strength.

and a BEARISH crossover will offer the agreement that a trader would want to consider the signal ‘very strong. if price is above Kumo – traders look at the pair as being BULLISH. with price and the Trigger/Base crossover residing above Kumo – Traders will generally look upon this signal as being ‘very strong. Remember. When the Trigger line crosses up and over the Base line (which is a bullish signal) AND price is above Kumo (a bullish environment) – Traders will enter into LONG positions considering the Signal to be ‘very strong. Pricing below Kumo indicates BEARISHNESS.15 Trading with Clouds When BULL CROSS 3 takes place.’ The reason that traders will generally consider BULL CROSS 3 to be strong is because of AGREEMENT.’ BEARISH crossovers taking place ABOVE Kumo would be looked at as weak. Page 15 .’ The exact opposite is true for SHORT signals. BEARISH crossovers taking place below Kumo are generally considered to be ‘very strong.’ because – once again – we have that AGREEMENT.

Now that we know how to incorporate signal strength. or BEARISH crossovers BELOW Kumo). traders can potentially look to open a position for 1 lot. Scrolling back in time on Marketscope. When a moderate signal is generated. When ‘strong. When a weak signal is generated. traders can look to open a trade for 2 lots. Page 16 . we can manually back-test in the same manner we had done for the Trigger/Base Line Crossover. With this method – traders would be taking on larger trade sizes for signals that they felt were ‘stronger. and then moving forward one candle at a time to observe the way that the currency pair traded after receiving each of the signals outlined above.16 Trading with Clouds How to Use Signal Strength Now that we know how to integrate Kumo when we receive a Trigger/Base crossover. One very popular method involves trade size. let’s talk about one of the more popular ways that traders look to benefit from the ‘strength.’ signals that offer agreement (BULLISH crossovers ABOVE Kumo.’ Other traders may choose to take only the ‘very strong.’ of the signals produced by Ichimoku.’ signals take place traders can enter a position for 3 lots.

that is generally looked at as BULLISH (price is higher than 26 periods ago). or complicated mathematics required – it’s just an iteration of current price plotted 26 periods late.”) is just current price plotted 26 periods ago.’ as I call it . let’s take a look at the last component of Ichimoku.can work similarly to Kumo.’ is in showing where current price action is in relation to where price action was 26 periods ago.’ the signal taking place from the Trigger/Base crossover is.17 Trading with Clouds ‘The Filter’ Now that we know how to incorporate ‘Kumo. Chinkou-Span (referred here-on-out as ‘The Filter. in that it can help us determine how ‘strong. That’s it. If price of the current candle is higher than price was 26 periods ago. No scientific calculations. The value of ‘The Filter. Page 17 . ‘The Filter.’ into our Trigger/Base Line crossover.

Page 18 . Let’s walk through a couple of examples to see how traders are using ‘The Filter.’ with Ichimoku trading signals.18 Trading with Clouds If price of the current candle is lower than price 26 periods ago. that is generally looked at as BEARISH (price is lower than 26 periods ago).

BEARISH Crosses of Trigger/Base BELOW Kumo are made even stronger with confirmation of ‘The Filter. This indicates that the trend may be very strong to the upside – and potentially conducive for LONG positions.’ being below price action 26 periods ago. Traders could interpret this signal. we can observe that this long signal is potentially even stronger that we may have initially thought – confirmed by the fact that ‘The Filter.19 Trading with Clouds In the example below.’ is above price action 26 periods ago. If you remember from the last lesson – we learned that this is a LONG signal that traders would generally interpret as ‘strong. Page 19 .’ due to the AGREEMENT between the crossover and the location of price with respect to Kumo. as ‘extremely strong. and Filter confirmation of our BULLISH signal.’ as there is now Kumo. The exact opposite would be the case for SHORT positions. Now that we can incorporate ‘The Filter. notice that a BULLISH Crossover has just taken place ABOVE Kumo.’ into the strategy.

This takes place ABOVE Kumo.’ could potentially keep us from entering into positions we may not want. Page 20 . notice that there are 2 Trigger/Base Crossovers taking place ABOVE Kumo. Observe the first signal – which would have been a BEARISH Signal as the Trigger has crossed DOWN and UNDER the Base Line. and ‘The Filter. and ‘The Filter. In the chart below. as you can see from the chart – choosing to go short here wouldn’t have worked out too well.20 Trading with Clouds Let’s look at an example where ‘The Filter.’ And. The BEARISH signal we have just received DISAGREES with the BULLISHNESS we are seeing on both Kumo.’ is also ABOVE Kumo – both indicating BULLISHNESS.

and ‘The Filter. if you notice Signal 2 taking place shortly after. Traders would consider this LONG BUY signal to be ‘extremely strong. and ‘The Filter. you will see that we have a BULLISH cross as the Trigger crosses UP and OVER the Base Line. Kumo.’ residing above Price Action at the time of the signal. one mannerism that traders often use to become more familiar with ‘The Filter.’ is built 26 periods behind current price.21 Trading with Clouds However.’ is forward-test on demo accounts. manually back-testing this part of the indicator can be challenging.’ Because ‘The Filter. On Signal 2 – we have AGREEMENT: The BULLISH Crossover agrees with the BULLISH state of Kumo (price is ABOVE Kumo). setting the size of the lot traded based on how strong the signal was. Page 21 . However.’ as there is AGREEMENT between the signal.

This aspect of the indicator is a little more open to interpretation. as traders can customize methods of managing their trades based on their own individual needs. These traders could base the trade size on the strength of the signal – just as we had walked through in the previous section. they could take every crossover that is generated regardless of signal strength.’ ABOVE price 26 periods ago – Weak signal (1 Lot) Crossover taking place in Kumo/Filter in Kumo – Moderate Signal (2 Lots) Below Kumo & ‘The Filter. In this section.22 Trading with Clouds For example – on BULLISH Crossovers: Below Kumo & ‘The Filter BELOW price 26 periods ago – Weak Signal (1 Lot) Crossover taking place between Kumo.’ Below Kumo – Very Strong (3 Lots) Setting Risk with Ichimoku Up until now. we’ll look at mannerisms for setting risk based on Ichimoku. Filter in Kumo – Moderate Signal (2 Lots) Above Kumo & ‘The Filter. And that is the management of risk.’ is above price 26 periods ago – Very Strong (3 Lots) On BEARISH Crossovers: Above Kumo & ‘The Filter. we’ve focused primarily on the entering into positions based on Ichimoku – but we haven’t yet talked about the part of trading many traders consider to be even more important than the entry. Decide how aggressive you want to be The first thing that a trader needs to decide when using Ichimoku is how aggressive they would like to be with the signals that are generated from the Trigger/Base Line Crossover. If a trader wanted to be very aggressive. Page 22 .

’ signals. may choose to take only the ‘extremely strong. SHORT positions are only being opened when price is BELOW Kumo.’ Below Kumo – Strong Signal (3 Lots) Traders that are more conservative.23 Trading with Clouds For example – on BULLISH Crossovers: Below Kumo & ‘The Filter BELOW price 26 periods ago – Weak Signal (1 Lot) Crossover taking place between Kumo. or choosy with their signals. and ‘The Filter. Page 23 . This way –they are only entering into LONG Positions when price is ABOVE Kumo. and ‘The Filter.’ ABOVE price 26 periods ago – Weak signal (1 Lot) Crossover taking place in Kumo/Filter in Kumo – Moderate Signal (2 Lots) Below Kumo & ‘The Filter. Let’s walk through a few examples together.’ is above price 26 periods ago. Filter in Kumo – Moderate Signal (2 Lots) Above Kumo & ‘The Filter.’ is above price 26 periods ago – Strong Signal (3 Lots) On BEARISH Crossovers: Above Kumo & ‘The Filter.’ is BELOW price 26 periods ago.

and observing ‘The Filter. This crossover takes place ABOVE Kumo. Remember – traders generally look for AGREEMENT between the signal and where price is in relation to Kumo. Signal 1 takes place as the Trigger Crosses up and OVER the Base line. Signal 3 is a BULLISH crossover that takes place inside of Kumo. Page 24 .’ signals may look to enter a trade to go long for 1 lot.’ of this ‘extremely strong. Let’s go through each of these in the order they took place. Traders will generally interpret this as bullish. Aggressive traders may look to place a trade to go short for 1 lot – as they want to act on ALL signals generated by Ichimoku.’ signal. Traders will generally consider this to be a signal of moderate strength.’ at the time would have showed the trader that ‘The Filter.’ reading was higher than price 26 periods ago – and this would be an extremely strong signal. Signal 2 is a BEARISH signal – as the Trigger crosses DOWN and UNDER the Base Line. More conservative traders that were only going to take the ‘extremely strong.24 Trading with Clouds On the chart below. you’ll notice 3 Trigger/Base crossovers – all outlined with red circles. Conservative traders may prefer to not act – and wait until a stronger signal is generated. This takes place ABOVE Kumo. Aggressive traders taking all signals generated by Ichimoku might decide to place a trade for 3 lots to account for the ‘strength.

there are multiple ways of setting stops with Ichimoku. Additionally.’ stops on their trades. risk. Traders choosing to be ‘aggressive. First – I would like to point out that sound principals of money.’ will generally look to place ‘tighter. or perhaps continue waiting until a more decisive signal was generated.’ traders generally try to allow more ‘wiggle room. If you are unfamiliar with money management. This is available to ALL Live clients of FXCM (accessible directly by clicking on the link below). Page 25 .’ signals. and account management are always suggested – regardless of what system you may be trading.25 Trading with Clouds Aggressive traders may look to place a trade for 2 lots to account for the moderate strength behind the crossover. ‘weak. DailyFX+ Trading Course The area of the Ichimoku indicator that is chosen for stop placement is largely going to be dependent on how aggressive traders would like to manage their positions. Conservative traders may look to another currency pair. whereas ‘conservative.’ signals that are generated present a different set of options over ‘strong. Setting stops with Ichimoku Once a position is opened.’ and ‘extremely strong.’ for their trades. we present an entire module with nearly 1 hour of On-Demand Videos on the topic within the DailyFX+ Trading Course. Let’s look at a few options below.

Ichimoku is either BULLISH or BEARISH at any point in time – but never both at the same time. weak signals offer the fewest possible points of interest for settings stops – as we do not have the luxury of Kumo. they can set the stop of their long position on the Base Line. traders can look to 2 common areas to set their risk on the trade.26 Trading with Clouds Weak Signals As you can see from the chart below. For traders looking to trade with a tight stop.’ It’s important to remember – if a Trigger/Base Line Crossover generates an opposing signal – the previous signal is no longer valid. However. Page 26 . allowing the trade more room (and potentially a larger loss if signal is incorrect) could set their stops at the most recent ‘swing high ’or‘ swing low. Traders preferring to be more conservative.

When Kumo expands and gets wider – that is accounting for increased volatility. The risk with this stop is that shorter-term ‘noise.’ can potentially take us out of the trade. You may notice that the width of Kumo will continually expand and contract. the various areas that can be looked to for setting of stops.27 Trading with Clouds Strong Signals Strong signals bring the luxury of being able to utilize Kumo for the setting of stops. Kumo can be looked at as a moving area of support and/or resistance – and can help incorporate volatility into our trades. Just as we had in the ‘weak. Page 27 . Notice on the chart below.’ signal – the Base Line offers a ‘tight’ stop on the position. When Kumo contracts and gets more narrow – that indicates decreased volatility.

28 Trading with Clouds Traders in the long position above can also look to Kumo – using any area within the range of Kumo. If we are in a LONG BUY position. The most common way of managing a trade via Ichimoku is manually moving the stop. lower if in a SHORT SELL position) as the position moved in our favor.’ the bottom line of Kumo. Manually Trailing the Stop Trailing a stop would be moving the stop further in the direction of the trade (higher if in a LONG BUY position. we can continue to ratchet our stop (higher for LONG BUYS. If the Trigger Line is higher than the Base Line – this is BULLISH – and traders would generally want to be in LONG BUY positions. lower for SHORT SELLS) with the goal of locking up more of the gain in the position. and the Trigger line crosses down and under the Base Line – that could be looked at as a potential closing signal. Traders can set the top line of Kumo as their stop – or if wanting more room for the position to ‘wiggle. Managing Trades via Ichimoku It’s important to note – at any one point in time Ichimoku is BULLISH or BEARISH depending on the location of the Trigger and Base Lines. Page 28 .’ to our stop. so that if the position begins moving against us – we have profit ‘built-in. we can look at that as a potential closing signal. The goal of which is to lock up profit. Let’s go over a couple of the more common methods of managing trades via Ichimoku. If the Trigger Line is below the Base Line – this is bearish – and traders would want to be in SHORT SELL positions. If we are in a SHORT SELL position and the Trigger line climbs up and over the Base Line – once again. As the position goes further into potential profit.

’ their stop. traders can choose to ‘trail. Page 29 .29 Trading with Clouds Automatically Trailing Stop Traders on FXCM’s platforms have the options of using trailing stops that will automatically adjust without any additional input from the trader needed. the stop will automatically be adjusted based on that trader’s preferences. As the position moves into the traders favor. With this option.’ their initial stop. Traders can choose to ‘trail.

’ report on DailyFX. and click on the link for ‘Trading Course. DailyFX+ Live Trading Room Each Tuesday.’ To be notified of upcoming events for Ichimoku. To login to the DailyFX+ Trading Room. please email Instructor@DailyFX. including the weekly Ichimoku Report as well as Live Webinar Sessions. I host a Strategy Session that is available for any live account holder of FXCM. join us for our weekly ‘Ichimoku. login. we offer live webinars 3-4 times per day in the Trading Room. with Ichimoku as the subject line.Com. you can navigate to DailyFX+.30 Trading with Clouds Now that you know the basics of trading with this fascinating indicator.com. as well as the weekly Live Session that is available to all live clients of FXCM as part of DailyFX+. In the DailyFX+ Trading Course. Page 30 .

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