It has several peculiarities that make it very different from other types of indicators and oscillators. It has also inspired several theories based around it; namely Ichimoku time theory and Ichimoku wave theory. Ichimoku can be a bit bewildering to start with because of the various outputs it produces. Once you get to know the meaning of each part it is quite straightforward. When you split the indicator up into separate parts it becomes much easier to understand.
I find it easiest to think of these together and refer to them as the fast line and slow line. They are derived in the same way but are at a different scale. These two lines are comparable to the fast and slow moving average but they do have some important differences. Traders see the interplay between these two lines as a gauge of things like momentum, pivot, support and resistance.
The chart in Figure 2 shows the equilibrium lines with everything else removed. The fast line is red and the slow line is blue. As you can probably see from the chart, these two lines look much like a fast and slow moving average. Each line is the average between the peak and trough over a certain span.
This might seem like splitting hairs but actually it gives the lines some unique properties. The peak and trough in a chart can stay the same for some distance; until the price touches a new high water mark or low water mark.
Between points 1 and 2 the peak and trough over the span stays the same. The price is ranging between the high water mark and the low water mark. At point 2, the price touches a new low. Thus only at this point will the line change.
It moves down a notch because the new low water mark is lower than the previous one. Compare this to the orange line which is the 30 bar moving average. This line is smooth and continuous. The idea is that using the price extremes creates a more stable measure of price equilibrium. Users of Ichimoku say this gives a stronger indication of support and resistance.
This gives the Ichimoku its distinctive appearance. As with the equilibrium, you can think of one of these as a fast line, and the other a slow. The way to think of the cloud is as a reflection of where the average price band has been in the past.
Traders use this to try to figure out where it is likely to go next. This idea is based on retracement and on the idea that market patterns tend to repeat themselves. The price tends to retrace to former levels and these are often revisited several times before a breakout occurs. For example, if you look at Figure 4, the lead span 3 shows a dip just in front of the current price. This shaded area is a reflection of the levels the price was at in the past at 1.
In this case the cloud reflects the dip that took place just before the current price peak 2. A kumo trader would predict that the price will retrace back to the shaded area 3 with a higher probability than rising again beyond 2. This is explained later in the example. The final line is a bit obscure. You might look at this line and think it looks like a wonderful signal to trade on. This is a delayed line. The lag line is simply the current closing price, projected backwards in the chart. So why does Ichimoku define this line?
But kumo traders would no doubt disagree. According to them the lag line is useful for three things:. The first is the easiest to understand. With trend confirmation, you would just take the difference between the current price and the last point in the lagging line.
In Figure 5, this distance is shown with an arrow. A positive value tells you the current price has moved upwards and by how much. A negative value tells you the price has moved downwards over the span period. The second use for the lagging line is in detecting repeatable patterns.
As Figure 5 reveals there seems to be a cyclical movement going on at least during some sections of the chart. The lagging line exposes this because its peaks or troughs will line-up with the peaks and troughs in the price. Thirdly, it acts as a final arbiter. Now what is the best way to make use of the Ichimoku in a trading situation?
Each of these components provides valuable perspective on which to trade. The equilibrium lines measure trend direction and rate of change at the current time. The cloud predicts trend direction and rate of change in the future. For example see Figure 6.
The cloud and the equilibrium lines provide a good forecast of support and resistance. A wide or deep cloud means more volatility and less certainty on direction. While a narrow, flat cloud means the market is more stable. Kumo traders talk a lot about equilibrium. When the price is above the cloud it indicates a bullish market. When the price is below it indicates a bearish market. So for example if the price has extended far above the cloud this is a signal that a downward correction is likely.
Figures 4 and 6 show some examples. As an example, take the chart from Figure 4. I took that snapshot yesterday. Looking at the kumo cloud: The first thing to notice is that the cloud is displaying a bearish downward crossing at point 2. The fast line has passed down, through the slow line. The purple shaded area is therefore expected to act as a price attractor, pulling it downwards.
The flat area at the top of the cloud creates support but the price has already made a significant break below this level at the current bar. One break below has already taken place. So we can say based on the kumo that a downward retracement is more probable than a further upward leg at this point. Looking at the equilibrium lines: An upward crossing happened at point 1.
This leg now appears to be exhausting as the top of the fast line red is already flattening. Putting this together, a kumo trader would go short sell at point 2 based on these signals.
Figure 8 shows a snapshot of the chart 36 hours later. Click the picture to open an enlarged view. The price has indeed descended back into the retracement area as expected. The top of the red line did act as a strong resistance. Of course, this is just one example. Once you group the output lines and get to know their different functions, it is all relatively simple.
There are a couple of things I like about Ichimoku. Firstly, the kumo cloud gives you a forecast. This has a solid underpinning in retracement theory and repetitive market dynamics. This is your crystal ball. Secondly, the kumo cloud and equilibrium lines provide decent forecasts of likely support and resistance lines.
The fact that Ichimoku uses price extremities rather than averaging means it is better suited to revealing market turning points. Leave this field empty. Using Ichimoku Kinko Hyo: Average line from the peak and trough compared to moving average line. Want to stay up to date? Just add your email address below and get updates to your inbox. Leave this field empty if you're human: The Bearish Breakaway A bearish breakaway is a chart formation that can appear in a rising market when the price starts to The Bullish Breakaway A bullish breakaway is a chart reversal pattern that can appear in either a bullish or bearish market Leave a Reply Cancel reply.