Ichimoku Cloud Indicator, Strategy & Scanner Explained

What is the Ichimoku Cloud?

The Ichimoku Cloud is a collection of technical indicators that show support and resistance levels, as well as momentum and trend direction. It does this by taking multiple averages and plotting them on the chart. It also uses these figures to compute a "cloud" which attempts to forecast where the price may find support or resistance in the future.

The Ichimoku cloud was developed by Goichi Hosoda, a Japanese journalist, and published in the late 1960s. It provides more data points than the standard candlestick chart. While it seems complicated at first glance, those familiar with how to read the charts often find it easy to understand with well-defined trading signals.

Components of the Cloud

Several elements make up the Ichimoku Cloud. The elements consist of the following five moving averages: 

1. Tenkan-Sen

The first component of the Ichimoku Cloud is the Tenkan-Sen, often represented by a red line on the chart. It is a moving average that is calculated by taking the average of the high and the low for the last nine periods. The market is deemed to be trending if the Tenkan-Sen is moving up or down. However, if the line moves horizontally, it indicates a ranging market. It is calculated as follows:

Tenkan-Sen = (9-Period Highest High + 9-Period Lowest Low) / 2 

2. Kijun-Sen

The Kijun-Sen is a support/resistance line that acts as an indicator of price movements in the future. It is usually represented by a blue line. The Kijun-Sen is similar to the Tenkan-Sen but takes a longer time frame into consideration, usually 26 periods compared to Tenkan-Sen’s nine periods. It measured by taking the average of the highs and lows for the last 26 periods. When plotted on a chart, the Kijun-sen typically lags behind the Tenkan-sen since the former comprises longer periods than the latter.

Kijun-Sen= (26-Period High + 26-Period Low) / 2

3. Senkou Span A

Senkou Span is the average of the highs and lows of Tenkan-Sen and Kijun-Sen and is plotted 26 periods to the right. On a chart, the Senkou span A is represented by an orange line. If the security price is above the Senkou span A (orange line), the top and the bottom lines become the first and second support levels, respectively. Conversely, when the price moves below the Senkou span A, the bottom and the top lines become first and second resistance levels, respectively.

Senkou Span A = (Tenkan-Sen + Kijun Sen) / 2 

4. Senkou Span B

It is calculated by taking the average of the high and low of the last 52 periods and plotting it 26 points to the right.

Senkou Span B = (52-Period High+ 52-Period Low) / 2

5. Chikou Span

The Chikou Span, also known as the lagging span, is represented by a green line. It is formed by taking the current price and shifting it back 26 periods to the left. If the Chikou span crosses the price from the bottom-up, it demonstrates a buy signal. However, if the line crosses the price from the top-down, it is a sell signal. 

Ichimoku Cloud Signals

The cloud provides the trend direction, and it also indicates support and resistance levels. It is formed by the two Senkou Span lines, A and B. The trend is dependent on the location of price vis-a-vis the cloud. For example, when the price is above the cloud, the trend is up, while the trend is down when the price is below the cloud. If the price is in the Ichimoku Cloud, the trend is flat or undetermined.

The strength of the trend can also be influenced by the position of Senkou span A and B. For example, when A moves above B, the trend is stronger in the bottom-up direction, while the opposite is true when Senkou span B moves above Senkou Span A.

When the Tenkan-Sen line moves above the Kijun-Sen line, this is a buy signal. Ideally, the two lines and the security price should be above the Ichimoku Cloud. On the other hand, when the Tenkan line (red line) intersects and goes below the Kijun-Sen line, it yields a sell signal. The two components and the price should also be located below the cloud. Traders may use other indicators like the Relative Strength Index to complement the Ichimoku Cloud indicator with the goal of maximizing their risk-adjusted returns.

How to Calculate Ichimoku Cloud

The highs and lows are the highest and lowest prices seen during the period. For example, the highest and lowest prices seen over the last nine days in the case of the conversion line. Adding the Ichimoku cloud indicator to your chart will do the calculations for you, but if you want to calculate it by hand here are the steps.

• Calculate the Conversion Line and Base Line.
• Calculate Leading Span A based on the prior calculations. Once calculated, this data point is plotted 26 periods in the future.
• Calculate Leading Span B. Plot this data point 26 periods into the future.
• For the Lagging span, plot the closing price 26 periods in the past on the chart.
• The difference between Span A and Span B is colored in to create the cloud.
• When Leading Span A is above Leading Span B color the cloud green. When Leading Span A is below Leading Span B, color the cloud red.
• The above steps will create one data point. To create the lines, as each period comes to an end go through the steps again to create new data points for that period. Connect the data points to each other to create the lines and cloud appearance.

What Does the Ichimoku Cloud Tell You?

The technical indicator shows relevant information at a glance using averages.

The overall trend is up when the price is above the cloud, down when the price is below the cloud, and trendless or transitioning when the price is in the cloud.

When Leading Span A is rising and above Leading Span B, this helps confirm the uptrend, and space between the lines is typically colored green. When Leading Span A is falling and below Leading Span B, this helps confirm the downtrend. The space between the lines is typically coloured red, in this case.

Traders will often use the Cloud as an area of support and resistance depending on the relative location of the price. The Cloud provides support/resistance levels that can be projected into the future. This sets the Ichimoku Cloud apart from many other technical indicators that only provide support and resistance levels for the current date and time.

Traders should use the Ichimoku Cloud in conjunction with other technical indicators to maximize their risk-adjusted returns. For example, the indicator is often paired with the relative strength index, which can be used to confirm momentum in a certain direction. It's also important to look at the bigger trends to see how the smaller trends fit within them. For example, during a very strong downtrend, the price may push into the cloud or slightly above it, temporarily, before falling again. Only focusing on the indicator would mean missing the bigger picture that the price was under strong longer-term selling pressure.

Crossovers are another way the indicator can be used. Watch for the conversion line to move above the baseline, especially when the price is above the cloud. This can be a powerful buy signal. One option is to hold the trade until the conversion line drops back below the baseline. Any of the other lines could be used as exit points as well.

The Difference Between the Ichimoku Cloud and Moving Averages

While the Ichimoku Cloud uses averages, they are different than a typical moving average. Simple moving averages take closing prices, adds them up, and divide that total by how many closing prices there are. In a 10-period moving average, the closing prices for the last 10 periods are added, then divided by 10 to get the average.

Notice how the calculations for the Ichimoku cloud are different? They are based on highs and lows over a period and then divided by two. Therefore, Ichimoku averages will be different than traditional moving averages, even if the same number of periods are used.

One indicator is not better than another, they just provide information in different ways.

Limitations of Using the Ichimoku Cloud

The indicator can make a chart look busy with all the lines. To remedy this, most charting software allows certain lines to be hidden. For example, all the lines can be hidden except for the Leading Span A and B which create the cloud. Each trader needs to focus on which lines provide the most information, and then consider hiding the rest if all the lines are distracting.

Another limitation of the Ichimoku Cloud is that it is based on historical data. While two of these data points are plotted in the future, there is nothing in the formula that is inherently predictive. Averages are simply being plotted in the future.

The cloud can also become irrelevant for long periods of time, as the price remains way above or below it. At times like these, the conversion line, baseline, and their crossovers become more important, as they generally stick closer to the price.

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