This article assumes the reader has basic knowledge of the Ichimoku Kinko Hyo trading system; an introduction can be found here. As you know, Ichimoku Kinko Hyo is predominantly a trend-following indicator, with multiple confirmations in built within the system.
We will share with you here how you can further enhance the system by utilising other (Western) indicators to confirm or better time your trades, for trend following in particular. The indicator we are discussing is the Average Directional Index (ADX) Indicator.
The ADX was developed by J. Welles Wilder to determine the strength of a trend, and whether the market is trending or not, regardless of direction. This is useful because markets tend to range about 80% of the time and if you are a trend trader, you will not want to miss the trends or enter trades prematurely. The ADX is an oscillator which fluctuates between 0 and 100, with a reading above 20 signalling a trend, and a reading above 40 signalling a strong trend.
In most charting packages, the ADX line is accompanied by 2 other lines called the Positive Directional Indicator (+DI) and the Negative Directional Indicator (-DI). Generally, a buy signal occurs when +DI moves above -DI and a sell signal when +DI moves below the +DI. In a ranging market, this happens frequently and produces trade-unfriendly whipsaws so it is not advisable to trade solely on +DI/-DI crossovers.
Using ADX with Ichimoku Kinko Hyo
Figure 1: Ichimoku Chart with ADX Indicator Below
Ichimoku traders commonly use the Tenkan Sen/ Kijun Sen cross for trend following entry/exit triggers, with confirmations from the other elements such as the kumo break and direction of future kumo, as well as the Chikou Span.
However, from the chart above, it is evident that the ADX is also a powerful way to confirm a trend. Starting from the left (black) vertical line of the green shaded portion, you will see that Tenkan Sen has not yet crossed Kijun Sen. During this time, the Ichimoku Kinko Hyo system alone will paint a bearish price action picture. But observe that +DI is above –DI, giving an early signal of a bullish movement. The ADX is also above 20, signalling a strengthening trend. A confirmation from both the indicators gives a trader more conviction in a bullish sentiment.
Likewise, observe the right (black) vertical line of the green shaded portion. With Tenkan Sen above Kijun Sen and a thick bullish Kumo ahead, price is strongly trending upwards. However, we see the +DI crossing below the –DI, signalling a bearish sentiment and a potential exit on long positions. It works out very well in this scenario to exit the long position as we see shortly after price starts to head south.
This showcases how the ADX can be timelier in trade exits, as opposed to waiting for the Tenkan Sen to cross below Kijun Sen (9 periods later). Another way traders observe the ending bullish trend is through the divergence observed, when price is making higher highs while the ADX reading is making lower highs.
Not every trade will paint such a “perfect” picture but ADX can be an extremely useful buddy to pair with the Ichimoku Kinko Hyo, as you have seen. And this works across multi assets classes.