What is it?
In the Japanese language “Ichimoku” means “cloud”. This famous indicator was created by Goichi Hosoda. Many market experts consider this indicator to be the most reliable trend indicator compared to others of that type, for instance, the moving averages.
At first glance, the indicator may seem intimidating. It is quite a complex system of calculations, but this makes this instrument so powerful and versatile. It can be used as a trend indicator, in order to identify the trend direction and reversal points. It could also be used in order to set support and resistance levels for the asset. The Ichimoku Cloud indicator is a wonderful base for any strategy, especially that it could be used alone, as a sufficient tool for technical analysis.
Conversion Line (Tenkan-sen) and Standard Line (Kijun-sen)
The Ichimoku cloud consists of five major components. The first ones are the Conversion Line (Tenkan-sen) (9 periods) and Standard Line (Kijun-sen) (26 periods) that act as dynamic support and resistance lines.
In the screenshot above you can see the two types of crossings between the two lines. Usually a cross of the faster Conversion Line ( blue) over Standard Line (red) signals a bullish trend bias or reversal while the opposite indicates bearish trend bias or reversal.
Conversion Line(Tenkan-sen) is calculated as (9-period high + 9-period low) / 2
Standard Line(Kijun-sen) is calculated as (26-period high + 26-period low) / 2
Conversion Line crossing over Standard Line indicates bullish trend bias or reversal, while the opposite indicates bearish trend bias or reversal
The Cloud: Cloud Line 1(Senkou Span A) and Cloud Line 2 (Senkou Span B)
Next comes the cloud. The cloud consists of two lines, namely the Cloud Line 1 (Senkou Span A) line and Cloud Line 2 (Senkou Span B) line. Both are plotted 26 periods in the future, meaning they are shifted 26 period ahead of the last candlestick.
How to read their signals? Usually if Cloud Line 1 is above Cloud Line 2, the cloud is of the green color, indicating a bullish bias, whereas in the opposite scenario the cloud is of the red color indicating a bearish bias.
Cloud Line 1 (Senkou Span A) is calculated as (Tenkan-sen + Kijun-sen) / 2
Cloud Line 2 (Senkou Span B) is calculated as (52-period high + 52-period low) / 2
Cloud Line 1(Senkou Span A) line above Cloud Line 2(Senkou Span B) indicates bullish bias, whereas in the opposite scenario bearish bias is indicated
The Lagging Line (Chikou Span)
Last but not least comes the Lagging Line (Chikou Span). It is peculiar that there is a lot of misunderstanding about this one and many investors do not know what it is and how to use it. Understanding how to use this line is critical for higher probability trades.
So, in short this line follows exactly the closing price of each period but is shifted back by 26 periods. In essence, the Lagging Line (Chikou Span) is a line chart shifted backwards 26 periods.
Usually when the Lagging Line crosses below past price action, the probabilities of a valid bearish move or reversal increase. In the opposite scenario of crossing above past price action, the probabilities of a valid bullish move or reversal increase.
Lagging Line (Chikou Span) above past price action indicates bullish bias, whereas in the opposite scenario bearish bias is indicated
How to use the Ichimoku Cloud strategy? 3 conditions to improve the odds
The Ichimoku indicator is considered to give reliable buy and sell signals for a reason. Unlike other indicators, the Ichimoku Cloud indicator can give multiple confirmation that together increase the probabilities for a valid buy or sell signal. That is why, as it was mentioned before, this indicator can be used on its on, whereas most indicators work best in combinations.
Here are 3 confirmations for a valid buy/sell signal with Ichimoku Cloud strategy:
- Bullish Price Close Outside the Cloud
The first and most critical condition for a valid buy signal is a bullish candlestick that closes above and outside the cloud for the first time. Such a breakout can be considered a sign that the price may continue its upward movement.
For a valid sell signal, a bearish candlestick should close outside and below the cloud for the first time.
2. Price is above the Conversion Line (Tenkan-sen) and the Standard Line (Kijun-sen)
The second condition requires that the bullish candlestick closes above both the Conversion Line and the Standard Line. Moreover, the Conversion Line should have already crossed above the Standard Line.
For a sell signal, the bearish candlestick closes below both the Conversion Line and the Standard Line. Moreover, the Conversion Line should have already crossed below the Standard Line.
3. Bullish Lagging Line (Chikou Span) cross over past price action
Last but not least for increased probabilities of a valid buy signal, the Lagging Line should have already crossed above past price action.
Likewise for a valid sell signal, the Lagging Line should have already crossed below past price action.
Setting up the Ichimoku Cloud indicator, one has to be attentive to its parts: the colors of each line as well as the period.
To set up the indicator on the IQ Option platform, first find it in the “Trend” section of the indicators’ menu.
Make sure to set the Indicator “by default” or change the settings according to your strategy.
Now you are ready to utilize the Ichimoku indicator in your trading routine! Make sure to look for the signals closely not to miss great opportunities. Good luck!