This article introduces the Ichimoku Kinko Hyo, an award winning Japanese technical indicator which can be used to trade currencies, commodities, futures, and stocks. Ichimoku means: one glance, Kinko means: equilibrium (or balance), and Hyo means: chart, which reads “one glance equilibrium chart”, describing how traders can very quickly discern price action of an asset, and form trading decisions effectively.
While this indicator can be implemented alongside other indicators such as trendlines and Fibonacci retracements, it is a powerful trading system on its own as it combines elements of time, sentiment, volatility, support and resistance.
How it All Began
Figure 1. Japanese Ichimoku Kinko Hyo materials
Five Lines in One SystemAt first glance, the indicator looks messy like a child’s painting. With a little patience and practice, this “mess” ironically makes chart reading a breeze. Here’s a snapshot:
Figure 2. Typical Ichimoku Kinko Hyo chart
The most distinctive feature of the Ichimoku Kinko Hyo is the red and blue cloud you see stretching across (and ahead of) price. Yes this is one of the rare indicators which forecasts price action ahead, contrary to what most believe technical analysis to be backward looking. Also known as the Kumo, the cloud is created by the two lines “Senkou Span A” and “Senkou Span B”. It is primarily an ever-changing support and resistance zone, serving as resistance above price and a resistance below price. At one glance, you can see whether price is currently bullish (above the cloud), bearish (below the cloud) or consolidating (inside the cloud).
Figure 3. Price position relative to Kumo
Figure 4. Kumo acts as support/ resistance
Figure 5. Varying strengths of Kumo support/ resistance
Figure 6. Bullish and Bearish Kumo Clouds
Figure 7: Cloud Formation 26 Periods Forward
The “Moving Averages”
Figure 8: Price Action Relative to Price Equilibrium (Blue Line)
Unlike the Simple Moving Average (SMA), Tenkan Sen and Kijun Sen lines often have flat portions which represent equilibrium and quite naturally, we see prices retracing back to their equilibrium. Savvy Ichimoku Kinko Hyo practitioners often wait for retracements before taking trades. As the Kijun Sen measures price action over a longer historical period, it is a more reliable indicator of sentiment and equilibrium, reflected by the longer flat lines/equilibrium compared to the Tenkan Sen.
Figure 9: Comparing Tenkan Sen and 9 Period SMA
Except for one instance in the chart above, prices stayed above the Tenkan Sen in the areas highlighted in yellow, while prices dipped below the SMA numerous times. We thus see how Tenkan/Kijun Sen can be more accurate than the SMA. The angle of the Tenkan Sen also shows us the momentum of price action, with stronger momentum depicted by a steeper angle.
Trading Strategy: Tenkan Sen/ Kijun Sen Crossover
Traders can look to go long (short) when the Tenkan Sen crosses above (below) the Kijun Sen. Unlike traditional SMA strategies, the strength of the Tenkan Sen/ Kijun Sen Cross can be ascertained based on its position relative to the cloud as follows:
Traders can exercise risk allocation and position sizing based on the strength of the crossover. The more conservative Ichimoku Kinko Hyo practitioners ignore weak crosses altogether.
Figure 10: Tenkan Sen/ Kijun Sen Cross Strategy
Identify Support/Resistance Lines
The Tenkan Sen, Kijun Sen, Senkou Span A and Senkou Span B all serve as support/resistance lines. Let’s take a look at this example:
Figure 11: Four Resistance Lines
History of 9, 26, 52
At this point, many of you are probably wondering how the number of periods 9, 26 and 52 came about in the various formula. As this indicator was created before WWII, Japanese financial markets were open for trading on Saturdays, meaning that the trading week was six days long.
9: represents a week and a half of trading
26: represents the number of trading days in a typical month (30 minus four Sundays)
52: represents two months of trading days
Japanese markets today trade only 5 days per week and 22 days in a typical month, so some practitioners of Ichimoku Kinko Hyo suggest revising the parameters to 7 or 8, 22 and 44. Others choose to follow the Fibonacci numbers of 8, 21 and 55. You can try the various parameters but every technical trader knows that indicators have a certain degree of self fulfilling traits, in the sense that if many people are (or have been all this while) looking at a certain indicator set with certain parameters, that indicator setting will work best. And this is the same for the traditional 9, 26 and 52 parameters for Ichimoku Kinko Hyo, based on our experience.
Last But Not Least
We have so far introduced four components of the Ichimoku Kinko Hyo trading system. The last, and some say the most important, is the Chikou Span, also known as the lagging Span. Its calculation is simple:
Chikou Span ("lagging line") = Current closing price time-shifted backwards 26 periods (into the past)
Figure 12: Picture of Bullish Chikou Span
Here you can see that the Chikou Span is simply the current period’s price shifted back 26 periods. When Chikou Span (purple line) is above price (26 periods ago), price action is bullish.
Some traders choose to remove the Chikou Span from their charts because they are able to visualise the Chikou Span without the need for the purple line. The Chikou Span is typically used as a final confirmation before entering a trade. In the chart example above, you may have a trade entry signal on a bullish kumo break; at this point many Ichimoku Kinko Hyo traders will use the bullish Chikou Span as a confirmation of a long position.
Figure 13: Picture of Bearish Chikou Span
In the chart above we see Chikou Span below price, a sign of bearish sentiment. In fact, price is in a strong bearish environment as we see a bearish Kumo ahead (Senkou Span A below Senkou Span B), as well as prices below the Kumo.
However the bearish trend may soon reverse, as we see Chikou Span threatening to “poke” through the candlesticks, as well as a potential weak bullish Tenkan/ Kijun cross up ahead. This is one way in which the Ichimoku system can identify trend reversals, and also an example of how the five components can work together to give you a picture of price action.
A Dynamic Trend-Following System
Figure 14: Overview Chart
The Ichimoku Kinko Hyo is largely a trend-following indicator, with the Tenkan/ Kijun cross as the key trigger for many traders. That being said, the multiple data points of the Ichimoku are to be used together to give the trader a well rounded picture of price action. Other indicators commonly used together with the system are Fibonacci retracements, pivot points, trend lines as well as the 20-day SMA, which is watched over by many institutional traders.
It is also useful to consider multiple timeframes when trading. For example if you trade the daily charts, you may want to visit the weekly and monthly charts to see where you are within the bigger trends. Alignment of shorter and longer period timeframes provides stronger conviction for your trading decisions.
About APF Trading
APF Trading is a trading advisory firm offering clients advice on multi-asset trading strategies, signals, trading systems, execution services and trading platforms. The firm also conducts research and technical analysis with a focus on Ichimoku Kinko Hyo and DeMark Indicators.