A student recently emailed me about an article that I had written a couple of years ago. The article, “One Look,” viewed the charting style known as Ichimoku. The student stated that he found this type of charting to be extremely beneficial for trading when the markets are currently making new highs. I decided to revisit the “One Look” charts and see what they may be telling us about this bull run in the equity market.
Ichimoku Kinko Hyo (Japanese for “one look equilibrium chart”), was created by a journalist to help identify trend and support or resistance in price quickly. It has gathered a great following by many technicians who use it to trade all asset classes.
There are five data plots on the Ichimoku chart. They are derived from highs and lows over a period of time. As we know, the definition of an uptrend is higher highs and higher lows while a downtrend is lower highs and lower lows. We use averages of these highs and lows in the cloud chart to determine trend direction, strength and potential reversal points.
Tenkan-sen (Conversion Line): (9-period high + 9-period low)/2)) – The default setting is 9 periods and can be adjusted. On a daily chart, this line is the mid point of the 9 day high-low range, which is almost two weeks.
Kijun-sen (Base Line): (26-period high + 26-period low)/2)) – The default setting is 26 periods and can be adjusted. On a daily chart, this line is the mid point of the 26 day high-low range, which is almost one month).
Senkou Span A (Leading Span A): (Conversion Line + Base Line)/2)) – This is the midpoint between the Conversion Line and the Base Line. The Leading Span A forms one of the two Cloud boundaries. It is referred to as “Leading” because it is plotted 26 periods in the future and forms the faster Cloud boundary.
Senkou Span B (Leading Span B): (52-period high + 52-period low) /2)) – On the daily chart, this line is the mid point of the 52 day high-low range, which is a little less than 3 months. The default calculation setting is 52 periods, but can be adjusted. This value is plotted 26 periods in the future and forms the slower Cloud boundary.
Chikou Span (Lagging Span): Close plotted 26 days in the past – The default setting is 26 periods, but can be adjusted.
Looking at these lines in my chart, it may seem a bit confusing to use the Ichimoku chart, but with knowledge and practice, it becomes rather simple.
The Leading lines form the cloud. The cloud can be viewed as a trend indicator as well as a support or resistance level. When price is trading above the cloud, it is generally viewed as being in an uptrend. If price were to correct in that uptrend, it often uses the cloud as a support area. When price trades below the cloud, it is said to be in a downtrend and shorting opportunities should be looked at. The cloud will often act as a resistance level in this case.
When price is inside of the cloud, this should be considered a no trade zone. The trend may be changing but is in turmoil at that point. A trader would be better off waiting for more confirmation of a trend before entering the market. Additionally, the thickness of the cloud can also hint at the strength of the trend. A wide cloud is harder to pierce and shows a stronger trend intact. When the cloud becomes narrow, it is more likely to be pierced as momentum has reduced in the trend.
For more confirmation of the strength of the trend, you can use the Chikou Span or Lagging Line. This is the current closing price plotted back 26 periods. When the lagging line is above prior price action, then your bullish trend is strong. If you see the line dipping below the candles on the chart, then the trend is weakening as the current closes are lower than they have been in the past. The same would be true for a bearish trend. The lagging line should remain below the prior prices. If it starts to move above, it is a warning that the bearish trend may be coming to an end.
These signals are similar to what you would receive from a Stochastic or CCI indicator. The Ichimoku chart is truly a “one look” chart as it can be used without any additional technical indicators other than price and perhaps volume. Next week I will discuss the use of the other lines and putting the Ichimoku chart to use for market and stock predictions. Until then, may all your trades be green and your losses small.