Ichimoku Kinko Hyo is a purpose built system developed by a Japanese newspaper man named Goichi Hosoda before World War II. It took him 20 years to develop and test the system and it was finally released in 1968. It has been used extensively in Asia to successfully trade currencies, commodities, futures and stocks. But didn’t really start appearing in the west until the 1990’s, mainly due to the lack of English translation on how to use the system.
The name Ichimoku Kinko Hyo translates as “Equilibrium at a glance” and it uses five separate components that are to be used in an integrated approach and not in isolation. It is designed to give a total picture of price action in a single glance, allowing the user to gain an immediate understanding of sentiment, momentum and strength of the trend.
Hosoda believed that the market was a direct reflection of human behaviour in a constant cyclical movement in and out of equilibrium. The system was designed to reflect this state of equilibrium.
The Ichimoku chart is composed of five indicator lines that work together to form a complete picture.
Tenkan Sen – Turning line: Highest High + Lowest Low/2 for the last 9 periods
The tenkan is often compared to a 9 period MA, but it quite different in that it actually measures the average of price’s highest high and lowest low for the last 9 periods. Using the average of price over a given period is a better measure of equilibrium than using the average closing price.
When flat, the tenkan indicates a trendless state over the last 9 periods. The tenkan provides price support much more accurately than a SMA due to the way it is calculated meaning it is less reactive to small movements in price and on a bearish chart, it will also act as a level of resistance.
The angle of the line is also an indicator of relative momentum of price over the last 9 periods. The steeper the line then the stronger the momentum.
The tenkan sen is a less reliable indicator than the Kijun Sen, due to the shorter time frame from which it is measured. However, when price breaches it, it can be viewed as an early warning of a trend change, but like all of the Ichimoku components, it cannot be viewed in isolation.
One of the main uses of the tenkan sen is its relationship to the kijun sen. When it is above the kijun sen, we have a bullish signal and when it is below we have a bearish signal. In fact, the crossing of these two lines is a very strong signal in itself and forms part of one the basic strategies that are used when trading this system.
Kijun Sen – Standard line: Highest High + Lowest Low/2 for the last 26 periods
The kijun sen provides us with the same information as the tenkan sen, but on a longer time frame and therefore tends to be a more reliable indicator. It can therefore be relied upon as a significant level of support and resistance. In fact, price tends to move alternatively away and back towards the kijun sen in a cyclical fashion, since it represents equilibrium. The kijun sen acts like a magnet and this is very evident when the kijun sen is flat. For this reason, many practitioners of Ichimoku use the kijun as a low risk entry point, but also as a solid stop loss in many alternative strategies.
Chikou Span – Lagging line: Current closing price time-shifted backwards by 26 periods
The chikou span represents one of the unique features of the system, that of time shifting. The current price is shifted back 26 periods and allows us to see how today’s price compares to that from 26 periods ago, helping us to determine the direction of the trend. If chikou is below the price from 26 periods ago, it means there is potential for continued bearish price action to come and vice versa. Also, one of the most useful features is the ability to identify clear levels of support and resistance extremely quickly. Practitioners can draw horizontal lines very quickly from the peaks and troughs created by chikou span directly on to their charts and quickly flick though all time scales to check for multiple time frame matches. Identifying Multiple time frame matches is one of the most successful trading techniques of the Ichimoku indicator.
Senkou Span A – 1st Leading line:(Tenkan Sen + Kijun Sen)/2 time shifted forwards by 26 periods.
Senkou Span B – 2nd Leading line:(Highest High+ Lowest Low)/2for the last 52 periods time shifted forwards by 26 periods.
The two Senkou spans, A & B create the most unique part of the Ichimoku system, ‘The Kumo Cloud’. The foundation stone of the charting system.
Senkou span A is shifted forwards 26 periods and represents the average of the tenkan sen and the kijun sen and is itself a strong representation of equilibrium. Knowing that price tended to respect historic support and resistance, Hosoda built this in to the system to allow users to quickly see at a glance where future support and resistance is likely to be.
Senkou span B represents the longest-term view of equilibrium over 52 periods and again is projected 26 periods in to the future ahead of current price action, allowing informed trading decisions.
It is possible to trade using both these indicators alone. However, the real power comes when using them in combination in the creation and guidance offered from the Kumo Cloud.
The Kumo Cloud: The Kumo (“Cloud” in Japanese) really is the heart and soul of Ichimoku charting. The kumo allows us to immediately ascertain the prevailing trend in one quick glance. The Kumo is one of the most unique aspects of Ichimoku, in that it provides a multi-dimensional view of support and resistance, rather than a single one dimensional view as provided by other charting methods. This more encompassing view gives a truer representation of how the market really functions, where support and resistance is not just a single point on a chart but rather, whole areas that are continually expanding and contracting in response to the market dynamics.
The Kumo cloud is comprised of two lines we have already seen. The Senkou span A and the Senkou span B. Each of these lines provides their own measure of equilibrium and used together they form the complete view of longer-term support and resistance. The space between these lines is the Cloud itself. This area is essentially a place of equilibrium or area of no trend. Price action can therefore be very volatile and unpredictable. However, it can also be used very effectively to trade in and around the Cloud. More on this later, when we discuss Advanced techniques.
The Kumo cloud really does provide a better, more reliable indicator of support and resistance than any other charting system. At times the ability to predict the future levels is nothing short of eerie….
The savvy Ichimoku trader understands that the area inside the Kumo is trendless, nevertheless he also understands the true importance of the top and bottom levels of the Cloud and how important they both are in terms of offering support and resistance.
Price in relation to the Kumo: When price is above the cloud, price is higher than the historical average, meaning stronger bullish sentiment. Likewise, the opposite is also true. The informed Ichimoku trader will always consult price’s position in relation to the Kumo to get their initial view of market sentiment and will always wait for price to move to the correct side of the cloud before opening trades on their chosen time frame. However, we can also use our knowledge and understanding of the Cloud boundaries to perform advanced trading techniques, that go against this rule. See advanced techniques, “Cloud Control”.
Kumo Depth: This can vary drastically from time frame to time frame and indicates market volatility. The thicker the cloud, the higher the volatility.
To understand why we need to keep in mind that Senkou A measures the average of the Tenkan and Kijun sen, so its period is between 9 and 26. Whereas the Senkou B measures the average of the highest high and the lowest low over 52 periods. Thus, Senkou span A is the faster line. Both lines are time-shifted forwards by 26 periods so that they always appear ahead of price action. The faster Senkou A indicates future price first, followed by Senkou span B.
From a trading perspective, the thicker the Kumo, the greater the support/resistance they provide. The savvy practitioner will use this to fine tune their risk management and trading strategies. I personally use it in all aspects of my own trading. From deciding on entry points to whether I enter hedging positions and trade recovery set-ups.
Kumo Sentiment: As well as providing a view of sentiment to price, the Kumo also gives its own indication of sentiment. This is easy to understand when we consider that it is essentially made up of two moving averages. One faster that the other. So when Senkou A, the faster of the two, is above Senkou B, we can see that we have a bullish sentiment in play, since the faster moving average is high or above. At times these two lines cross and switch place, this indicates an overall trend change from this longer-term perspective. This is called a “Kumo Twist” and is a trading strategy in its own right. This is covered in more detail in basic strategies.
One final, but very important aspect of the Kumo, is the occurrence of ‘Flat Top’ and ‘Flat Bottom’ Kumos. They are often observed. Just like the ‘rubber band’ effect that the Kijun sen can exert on price, a flat Senkou span B can and does act in exactly the same way, attracting price that is already in close proximity. This is easily explained as this line represents the midpoint of a trend less state, or equilibrium. Since price always returns to equilibrium, it is a strong attractor of price.
In a bullish trend, we get a flat bottom kumo, with Senkou span B on the bottom, in a bearish trend, the opposite is true. The Ichimoku practitioner can use their understanding of the physics of the Kumo to be more cautious about both their exists out of the Kumo. This is most useful in minimizing the risk of false breakouts.
After much research and back testing and, Goichi Hosoda determined the optimum settings of 9, 26 and 52 to obtain optimal results with the system.