Ichimoku Cloud: A Beginner's Guide to Low-Risk Ichimoku Strategies

Ichimoku Cloud: A Beginner's Guide to Low-Risk Ichimoku Strategies

Reading time: 9 minutes

Also known as the ‘Ichimoku Kinko Hyo’, the Ichimoku Cloud offers market participants an advanced indicator to help recognise areas of support and resistance, trend direction and momentum. 

What we get with this indicator is a technical analysis tool that provides an ‘instant view’ of the trend and offers trading signals. In fact, Ichimoku Kinko Hyo actually translates to ‘one look equilibrium chart’, an appropriate portrayal of the indicator, as with one glance, a great deal of potentially actionable information is available. For those interested in the indicator's history, it was conceived by a Japanese journalist named Goichi Hosoda and first launched in his book in the late 1960s. However, since then, several newer and easier-to-read books written by different authors have become available. 

Structure and Formula: Ichimoku Cloud

As evident from the daily chart of the EUR/USD below, the indicator consists of a number of components and can appear complex at first glance. Unlike what you would get with an isolated moving average, the Ichimoku Cloud works with five distinct lines to complete the indicator as described below: 

• Tenkan-Sen: Sometimes referred to as the ‘Conversion Line’ or ‘Turning Line’, the default period for this line is 9 periods, though, like all the following lines, it can be adjusted to suit a trader’s trading style. The calculation to establish the line is found by summing the highest high and the lowest low over 9 periods and subsequently dividing this value by two; this marks the mid-point of the high/low range over the past 9 periods.
• Kijun-Sen: Often referred to as the ‘Standard Line’ or the ‘Base Line’, this part of the indicator is calculated by summing the highest high and lowest low points of your chosen market over the past 26 periods and dividing this by 2 to give you the mid-point of the high/low range over the previous 26 periods.
• Chikou Span: This is sometimes called the ‘Lagging Line’ due to its application, which involves plotting the closing price 26 periods back.
• Senkou Span A: Also referred to as the ‘Leading Span A’, it is calculated by summing the Tenkan-Sen and the Kijun-Sen and dividing by 2 to deliver the mid-point between the two aforementioned lines. Of importance, this forms one of the lines that define either the upper or lower boundary of the Cloud and is considered leading as it is plotted 26 periods ahead (default). 
• Senkou Span B: This can be referred to as the ‘Leading Span B’ and is formed by locating the mid-point (found by dividing the value by 2) of the highest high and lowest low over the past 52 periods (default). This forms the other Cloud boundary and is also projected 26 periods ahead, but it is the slower of the two Cloud lines. 

Low-Risk Ichimoku Strategies

Conversion Line – Base Line (Tenkan-Sen – Kijun-Sen) Signal:

This is one of the more straightforward approaches. It involves looking for crossovers between the Conversion and Base Line. So, a bullish signal is established when the Conversion Line crosses above the Base Line, and vice versa for a bearish signal. These signals are generally best taken in established trends and can offer low-risk entries in a market, with some conservative traders opting to position protective stop-loss orders beyond the Cloud’s boundary. But, like any crossover system, the approach can yield numerous false signals when a market is ranging. 

Of note, traders can also use the Cloud (made up of the Leading Span A and B lines) as a means of identifying trend direction; when price is above the Cloud, this is considered a market that is in an uptrend, and for price trading below the Cloud reflects a downtrend. 

Below are some examples of bearish signals on the EUR/USD daily chart:

Cloud Support and Resistance:

Another straightforward approach to employing the Ichimoku Cloud is using the Cloud as a dynamic support and resistance area. Amidst strong trending markets, the Leading Span A is above (below) the Leading Span B in uptrends (downtrends), and the area formed between these two lines can provide traders with a support (resistance) area. 

As illustrated on the EUR/USD daily chart below, there are three examples of sell trades (short positions) where price is very clearly in a downtrend and has responded from the Cloud resistance and successfully continues to move lower. Traders tend to position protective stop-loss orders beyond the Cloud’s structure. Many traders who adopt this way of trading will also look to trail the position using the Cloud itself as a guide and only exit a trade when price reverses and, in a short position, trades back above the Cloud. The same is true for buy positions (long positions), only reversed.

The Kumo Twist:

The Kumo Twist is another beginner strategy that can be employed in all markets. Many claim that it is best used for swing trading, though others say day trading and scalping are possible with the Kumo Twist approach. 

When the Leading Span A, which, if you remember, is the faster side of the Kumo Cloud, turns and crosses beyond the slower Leading Span B, this is often viewed as a trend signal. So, a bullish signal materialises on the back of the Leading Span A crossing above Leading Span B and vice versa for a bearish signal, as demonstrated below on the EUR/USD daily chart. While this is a straightforward approach, it can be very difficult to implement when markets are consolidating. 

You will see from the example below that a Bullish Kumo Twist was seen at the beginning of 2023 and proved to be a successful trading signal, yet as we moved further into the year and began ranging, trading conditions were difficult; it is clearly easier to trade this method in a trending environment. 

In terms of traders entering and exiting the market using this approach, many traders enter on the closing candle following a Bullish or Bearish Kumo Twist signal and trail the position using the Kumo Cloud. As for the protective stop-loss order, traders tend to position it according to price action (they look for highs and lows to locate stop positions, for example). 

Summary:

• The Ichimoku Cloud indicator consists of five lines: Tenkan-Sen, Kijun-Sen, Chikou Span, Senkou Span A and Senkou Span B. 
• The Ichimoku Cloud is a versatile indicator offering signals that can complement other trading strategies, such as price action or other technical indicators, or even be combined with a fundamental trading approach. 
• At the core of the indicator, the Cloud delivers dynamic support and resistance and can be particularly effective in trending environments. 

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