The Ichimoku Kinko Hyo or equilibrium chart is a technical indicator that isolates higher probability trades in the forex market. More known for its applications in the futures and equities markets, the Ichimoku displays a clearer picture because it shows more data points, which provide a more reliable price action. This technique combines three indicators into one chart, allowing the trader to make the most informed decision. In this section, we'll learn how the Ichimoku works and how to apply the indicator in your trading.
Constructing an Ichimoku Chart
Let's take a look at an example of an Ichimoku chart so we have a visual point of reference. The Ichimoku chart consists of three lines (the red, maroon and pink shown below) and a "cloud":
|Figure 1: EUR/USD Ichimoku Chart|
1. Tenkan-Sen, or conversion line (red) - (Highest high + lowest low) / 2, calculated over the past seven to eight time periods
2. Kijun-Sen, or base line (maroon) - (Highest high + lowest low) / 2, calculated over the past 22 time periods
3. Chikou Span, or lagging span (pink) - The most current closing price plotted 22 time periods behind (optional)
4. Senkou Span A (green) - (Tenkan-Sen + Kijun-Sen) / 2, plotted 26 time periods ahead
5. Senkou Span B (blue) - (Highest high + lowest low) / 2, calculated over the past 44 time periods. Plot 22 periods ahead
The most important component of this indicator is the Ichimoku "cloud", which represents current and historical price action. It behaves in much the same way as simple support and resistance by creating formative barriers. The "cloud," known as the Kumo, is the space between Senkou Span A and Senkou Span B. The time period is most often measured in days; however, this can be modified to the trader's preference as long as it is consistent throughout all calculations.
Also, the "cloud" is comparatively thicker than your run-of-the-mill support and resistance lines. Instead of giving the trader a visually thin price level for support and resistance, the thicker cloud will tend to take the volatility of the currency markets into account. A break through the cloud and a subsequent move above or below it will suggest a better and more probable trade.
To calculate these figures manually, you can use a spreadsheet program like Excel (with formulas to speed up the process), and then plot the points on a time series chart. There are also several commercial charting programs that have this technique installed and can automatically show the Ichimoku chart in real time.
Interpreting the Chart
Now that we have a chaotic chart filled with colorful lines and strange clouds, we need to know how to interpret it. The Ichimoku chart can be used to determine several things. The following is a list of signals and how you can spot them:
A strong buy signal occurs when the Tenkan-Sen crosses above the Kijun-Sen from below. A strong sell signal occurs when the opposite occurs. The signals must be above the Kumo.
A normal buy signal occurs when the Tenkan-Sen crosses above the Kijun-Sen from below. A normal sell signal occurs when the opposite occurs. The signals must be within the Kumo.
A weak buy signal occurs when the Tenkan-Sen crosses above the Kijun-Sen from below. A weak sell signal occurs when the opposite occurs. The signals must be below the Kumo.
Strength is shown to be with the sellers if the Chikou Span is below the current price. Strength is shown to be with the buyers when the opposite is true.
Support and resistance levels are represented by the presence of the Kumo. If the price is entering the Kumo from below, then the price is at a resistance level. If the price is falling into the Kumo, then there is a support level.
Trends can be determined by simply looking at where the current price is in relation to the Kumo. If the price stays below the Kumo, then there is a downward trend (bearish); if the price stays above the Kumo, then there is an upward trend (bullish).
The Ichimoku charts give us a rare opportunity to predict market timing, support/resistance levels, and even false breakouts, all in one easy-to-use technique.
The Round Up
Intimidating at first, once the Ichimoku chart is broken down, every trader from novice to advanced will find the application helpful. Not only does it mesh three indicators into one, but it also offers a more filtered approach to the price action for the currency trader. Additionally, this approach will not only increase the probability of the trade in the FX markets, but will assist in isolating only the true momentum plays. This is opposed to riskier trades where the position has a chance of trading back former profits.
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