Ichimoku Cloud Explained.How to Use Ichimoku Trading Strategy

February 15, 2021 - Мария Давыдова

Watching trend development is highly important both for short-term and long-term trading. Most trading strategies reside on careful planning and observations. Naturally, investment specialists have birthed many trend indicators, whose goal is to improve or simplify the trend watching.

Ichimoku Cloud explained in this article is one of the more complex indicators, both in its purpose and the technical side. Ichimoku Cloud doesn’t just allow you to watch the trend. It’s also fairly efficient at predicting when the trend is going to reverse, which is the decisive time for selling or purchasing.

What is Ichimoku Cloud?

You can divide the Cloud into two parts. One is a combination of three general-purpose moving averages that register the trend changes based on the data obtained over periods of time with different lengths. The other is the Cloud itself, the unique part for which this strategy is known.

The first part consists of three moving averages:

1. A 9-day average
2. A 26-day average
3. A line of closing prices taken from the last 26 days

These are important because Ichimoku trading requires additional indicators, as the Cloud itself doesn’t really provide a clear picture on its own. The first two indicators are great for observing sharp changes in the recent price dynamic, and the closing line shows how much the average price declined closer to the end of the day.

The Cloud itself includes:

1. A moving average calculated as an average of 9 and 26-day period lines
2. A 54-day average.

The Cloud is designed very uniquely. Whenever the first line is above the second, the gap between them is colored in green. Otherwise, it’s red.

The logic is simple: if the more recent collection of data has sensed the change that the long-ongoing indicator (calculated over the course of 54 previous days) didn’t, the Cloud says the current trend is bullish. If the recent data registered a sharp decline and plunges below the 54-day trend, then the current trend might be bearish.

Why is Cloud useful?

The Cloud is great at letting you observe the price dynamic, especially in relation to other indicators. However, the colored gaps are not there just for style.

It’s also used to predict the coming zones of support and resistance. Remember: this strategy uses a 54-period indicator, a very fitting tool for long-term planning. Seeing how many assets reverse prices with at least some semblance of system, long-term indicators are essential for predicting the sharp changes.

Cloud is so useful because prices usually reverse in the zones of support (the ‘floor’) and resistance (the ‘ceiling’). The Cloud shows both where the stock value reversed before and that it’s going to reverse soon enough. As a result, the colored gaps fairly effectively signify the support and resistance zones.

The support and resistance zones are basically periods in the price chart where the current demand and supply situation forces the current trend to push back. If the trend is strong enough, it can continue to rise, but these situations aren’t very ordinary, and that’s why you also need other indicators alongside the Ichimoku Cloud.

How to work with Ichimoku Cloud?

When working with the Cloud, it’s essential to notice how high the gap of the Cloud is getting of late.

The line to change destinations earlier is the shorter period – it senses that the trend may be changing in the nearest future. The line with the longer period is going to change very reluctantly, as it shows the general trend, not the earliest dynamic.

So, it’s reasonable to expect the bearish downturn whenever the gap starts to open up or, more seldom, when they both start facing downwards.

But don’t trust the Cloud blindly. It’s not uncommon for the value to just continue climbing despite the fact that for the last several days the gap was wide and red, which indicates a soon bearish reversal.

Ichimoku Cloud marks the most likely zones of resistance and support, but given its highly historic character, it can’t take into account the unexpected shifts and developments. To ensure that you don’t miss sudden changes, you might consider using a more short-term indicator, like MACD.

Additional indicators

You might’ve noticed that Ichimoku Cloud is used to anticipate the sudden change in the same way many basic candlestick formations indicate the coming price shifts.

So, in addition to the three indicators you’re given to analyze from different periods, you may consider using something many investors come to analyze after spotting a possible candlestick formation – the volume.

The volume is the amount of specific shares traded on the market on the day in question. It can tell you all you want to know if you consider it in relation to the volumes of the neighboring days.

For instance, if the volume suddenly became scarce in relation to the previous days (and the price is currently at a very low point), then the product is simply overbought. And vice versa – if the product is at the very top and has run out of volume, then it’s oversold. In both situations, a sudden change of trend is imminent.

At the same time, you should not bother with numbers and respective analysis. You can simply whip out a Respective Strength Index (RSI) to help you understand whether the product is currently oversold or overbought. The index shows numbers from 0 to 100: the product is oversold if the number is 70 or more and overbought if it’s 30 or less.

If either of these is true, and you see that price is in or near the Cloud gap, then the trend is very likely going to change soon.