This article is based on the Ichimoku cloud as seen on Bitstamp’s Tradeview.
ICHIMOKU CLOUD ESSENTIALS:
- Ichimoku cloud is a technical indicator developed by Japanese stock analyst Goichi Hosoda.
- It consists of several elements:
- Tenkan sen
- Kijun sen
- Kumo cloud
- Chikou span
- The Ichimoku cloud has many use cases:
- Spotting support and resistance zones.
- Predicting uptrends (bullishness) and downtrends (bearishness).
- Identifying overbought and oversold levels.
- It is most useful when the market is in a strong trend (up or down), while it is not as reliable when the market is moving horizontally.
Ichimoku cloud basics and settings
The Ichimoku cloud indicator consists of:
- Tenkan sen (Conversion Line): 9-period moving average
- Kijun sen (Base Line): 26-period moving average
- Senkou span A (Leading span A): the moving average of the Conversion and Base Lines projected 26 periods into the future.
- Senkou span B (Leading span B): 52-period moving average projected 26 periods into the future.
- Chikou span (Lagging span): the closing price of the current period projected 26 periods in the past.
- Kumo cloud: an area formed between Senkou span A and Senkou span B.
Default settings of the Ichimoku cloud are: 9/26/52/26. This is derived from a 9-period Tenkan Sen moving average, 26-period Kijun sen moving average, 52-period Senkou span B moving average and 26-period displacement of Senkou span A, Senkou span B and Chikou span.
However, these settings are adjusted for the stock market, which is only traded during the work week. The cryptocurrency market is open and traded 24/7 and therefore the settings of the Ichimoku cloud should be adjusted to 20/60/120/30. These settings can be adjusted in Bitstamp’s Tradeview (click here to learn more about the Tradeview).
It is advisable to use the Ichimoku cloud with higher time frames. The most popular are the four-hour time frame (4h) and the one-day time frame (1D). This indicator works best when the market is in an uptrend or a downtrend. However, it is not really useful when the market is flat, as it can provide misleading signals.
There are different elements of the Ichimoku cloud that can be used to predict future market behavior.
Kijun sen
The Kijun-sen line is a dark-red color. The Kijun sen is used to determine support and resistance levels, while also playing a role in several bullish and bearish crosses.
When the market is in an uptrend and the price is trading above the Kijun sen, it has the role of support. Alternatively, when the market is in a downtrend and the price is trading below the Kijun sen, it acts as a resistance.
When the price corrects after an upsurge and bounces off the Kijun sen, this is called a Kijun bounce. If the price reaction is substantial when a Kijun bounce happens, this indicates the strength of the uptrend.
An important feature of the Kijun sen is also the Kijun cross. A Kijun cross observes the relationship between a Kijun sen and the asset’s price. When the price crosses above the Kijun sen, this indicates bullishness. The price crossing below the Kijun sen is a sign of bearishness.
Tenkan sen
The Tenkan sen is a standalone line of the Ichimoku cloud, colored blue by default. It is primarily used for spotting a TK cross. TK cross stands for Tenkan-Kijun cross, which signifies a market’s bullishness or bearishness; which one depends on how the cross happens.
TK cross
When looking for these occurrences, it is easiest to simply follow the Tenkan sen line (blue) and spot where and how it crosses the Kijun sen line (dark red).
When the Tenkan sen crosses above the Kijun sen it indicates bullishness. When this cross occurs above the Kumo cloud (more on the Kumo cloud below) it signifies exceptional bullishness. However, when the cross occurs below the Kumo cloud, it only signifies mediocre bullishness and should therefore be traded with caution.
When the Tenkan sen crosses below the Kijun sen, it is a sign of bearishness. This type of TK cross happening below the Kumo cloud is an extremely bearish signal, while its occurrence above or in the Kumo cloud indicates ordinary bearishness.
Kumo cloud
The Kumo cloud is an area of the chart bordered by two line boundaries: the Senkou span A and Senkou span B. The Senkou span A is ordinarily green, while Senkou span B is red. The area between them is colored in semi-transparent green when Senkou span A is above Senkou span B, or a semi-transparent red when Senkou span A is below Senkou span B. The Senkou spans are often called the edges of the cloud.
The same as Kijun sen, the edges of the Kumo cloud act as support and resistance, but at other price levels. When the price is trading above the Kumo cloud they represent support, while price trading below the Kumo cloud makes them act as resistance levels.
Kumo edge-to-edge
Kumo edge-to-edge is a trade setup which occurs when the price breaks into the cloud and candlesticks start closing within it. When this happens, the price target becomes the opposite edge of the Kumo cloud.
For a bullish scenario this means that when the cloud is above the price and candlesticks start closing within the cloud, the target becomes the upper edge of the Kumo cloud. This indicates a good zone to close long positions. Reverse is true for a bearish scenario, when the cloud is below the price and candlesticks start closing within the cloud, the target becomes the lower edge of the Kumo cloud. This presents a good price level for closing short positions.
Kumo breakout
When the price bursts through the cloud and continues to rise or fall below it, and continues to decline, this is called a Kumo breakout. If price manages to break through the top of the Kumo cloud this is a bullish signal, while price plummeting below the bottom line of the cloud signifies bearishness.
Kumo twists
The Kumo cloud color depends on the position of Senkou span A and Senkou span B (it is green if A is above B and red if A is below B). The color changes when a cross of the Senkou spans takes place, which is also known as a Kumo twist.
One of the most basic Ichimoku cloud use cases is to determine buy and sell opportunities by observing the current color of the cloud. A basic rule of thumb is that a green cloud is a buy signal, while a red cloud is a sell signal.
Chikou span
The Chikou span is a line in the Ichimoku cloud that is traditionally colored light green. It is a lagging span created by plotting closing prices 30 time periods behind the last closing candlestick price, meaning that the Chikou span at any candlestick traces the closing price 30 candlesticks ago.
Observing the Chikou span can be used to identify the relationship between the current and prior market trends. When a Chikou span is formed above the current price, it forecasts an uptrend, while a Chikou span below the current price forecasts a downtrend.
This can be utilized to confirm a trend continuation or to spot a potential market reversal.
Trend continuation:
- uptrend with Chikou span above the current price
- downtrend with Chikou span below the current price
Market reversal:
- uptrend with Chikou span below the current price
- downtrend with Chikou span above the current price
Ichimoku as an Oscillator
Last but not least, the Ichimoku cloud can be used as an oscillator, to predict whether the asset is oversold or overbought and has to be corrected in price. This can be read by observing the correlation between the Tenkan sen and Kijun sen. When the gap between them expands significantly, this indicates that the price has to be corrected. This can occur either in an uptrend or a downtrend.
The Ichimoku cloud is one of the most powerful and versatile technical indicators. It takes into account many different variables and can show several different trading signals (which can sometimes oppose each other). Mastering the Ichimoku cloud is therefore far from easy. Correct interpretation can take years of trial and error. But with patience and practice, it can be turned into one of the most indispensable tools in the arsenal of the skillful trader.