Ichimoku clouds are a technical analysis tool used in stock trading and other investment fields. The clouds are composed of five lines that can be used to identify current trends, support and resistance levels, and price targets.
The cloud formation is unique in visually representing the market’s trend, momentum, and volatility. Traders use Ichimoku clouds to make buy and sell decisions and set stop-losses and target prices.
The 5 Elements of Ichimoku Clouds
The five lines that make up the Ichimoku cloud are:
The Tenkan-sen line is the fastest moving average line and is used as a short-term trend indicator.
The Kijun-sen line is a slower-moving average line and is used as a long-term trend indicator.
The Senkou Span A line is the midpoint between the Tenkan-sen and Kijun-sen lines and is used as a leading indicator of future price action.
The Senkou Span B line is the slowest moving average line and forms one edge of the Ichimoku cloud. This line is also used as a leading indicator of future price action.
The Chikou Span line is the current price action plotted 26 periods behind. This line is used as a lagging indicator to confirm trends.
The Ichimoku cloud can be used in conjunction with other technical indicators to form a complete trading strategy. For example, many traders will use the clouds to identify entry and exit points and set stop-losses and target prices.
When using the Ichimoku cloud, it is important to remember that price action tends to respect the cloud formations. This means that when prices are above the cloud, it is generally indicative of an uptrend. Likewise, when prices are below the cloud, it is generally indicative of a downtrend.
The Ichimoku cloud is a powerful technical analysis tool that can be used to make informed trading decisions. When used correctly, the clouds can help you identify trends, set stop-losses and target prices, and maximize your profits.
Ichimoku Cloud Example
Look at the next example and read the notes below to understand the cloud.
Ichimoku Cloud Chart Notes:
- When a price pattern enters and breaks through the cloud downwards from above, this is a bearish sign.
- When a price pattern enters the cloud from below and breaks out up through the cloud, this is a bullish sign.
- The cloud can also indicate a good area of support for the price.
This is a weekly chart of the S&P 500 mapped against the Ichimoku Cloud.
The chart is mapped back to 2000, so we can visually compare the Dotcom crash ending in 2003 with the 2008 recession. How does the price compare with the Ichimoku cloud on both occasions?
The findings are extremely interesting!
- In September 2000, the price broke down through the cloud support signaling a market in decline.
- The market entered into a three-year bear market, finding support at 800 points 3 times in late 2002 and 2003.
- In August 2003, the S&P500 broke up through and out of the cloud and moved vigorously into a new bull market.
- Moving forward to November 2007, the market enters the cloud from above, and the ensuing bear market takes hold.
- On August 3rd, 2009, the S&P enters the cloud from below. This potentially bullish sign can only be confirmed when the index breaks out upwards through the cloud and moves higher on stronger volume.
- On the volume pane (middle pane), we see that on both occasions, the bottom of the market took place on reducing volume.
- We also see the MACD Histogram (weekly) has remained bullish since entering the cloud in 2009 as it did in 2003.
The Ichimoku cloud is an excellent way to visualize what stage the market is in.
The expectation is that once a stock or index enters the cloud from below, it will continue through the cloud and exit above the cloud, this signal a strong uptrend or bull market. Also, the opposite is true. If the stock or index enters the cloud from above, it is expected to break out through the bottom of the cloud, meaning a potential bear market.
In this section, we covered market trends and how to assess them. The important aspects to remember are the use of Dow Theory and the indexes must confirm. Important also is the types of trend, up, down, and sideways. Do not forget that a trend also has a short-term, medium-term, and long-term timeframe.
Other very useful concepts are that of Elliott waves and the Ichimoku cloud.
Formulate your opinion on market direction, and you will know if it is a good time to trade.
Further Reading: Advanced Ichimoku Analysis