What Is the Ichimoku Cloud?
The Ichimoku Cloud is a collection of technical indicators that show support and resistance levels, as well as momentum and trend direction. It does this by taking multiple averages and plotting them on a chart. It also uses these figures to compute a “cloud” that attempts to forecast where the price may find support or resistance in the future.
The Ichimoku Cloud was developed by Goichi Hosoda, a Japanese journalist, and published in the late 1960s.1
It provides more data points than the standard candlestick chart. While it seems complicated at first glance, those familiar with how to read the charts often find it easy to understand with well-defined trading signals.
The Ichimoku Cloud is composed of five lines or calculations, two of which comprise a cloud where the difference between the two lines is shaded in.
The lines include a nine-period average, a 26-period average, an average of those two averages, a 52-period average, and a lagging closing price line.
The cloud is a key part of the indicator. When the price is below the cloud, the trend is down. When the price is above the cloud, the trend is up.
The above trend signals are strengthened if the cloud is moving in the same direction as the price. For example, during an uptrend, the top of the cloud is moving up, or during a downtrend, the bottom of the cloud is moving down.
What Does the Ichimoku Cloud Tell You?
The technical indicator shows relevant information at a glance by using averages.
The overall trend is up when the price is above the cloud, down when the price is below the cloud, and trendless or transitioning when the price is in the cloud.
When Leading Span A is rising and above Leading Span B, this helps to confirm the uptrend and the space between the lines is typically coloured green. When Leading Span A is falling and below Leading Span B, this helps confirm the downtrend. The space between the lines is typically coloured red in this case.
Traders will often use the Ichimoku Cloud as an area of support and resistance depending on the relative location of the price. The cloud provides support/resistance levels that can be projected into the future. This sets the Ichimoku Cloud apart from many other technical indicators that only provide support and resistance levels for the current date and time.
Traders should use the Ichimoku Cloud in conjunction with other technical indicators to maximize their risk-adjusted returns. For example, the indicator is often paired with the relative strength index (RSI), which can be used to confirm momentum in a certain direction. It’s also important to look at the bigger trends to see how the smaller trends fit within them. For example, during a very strong downtrend, the price may push into the cloud or slightly above it, temporarily, before falling again. Only focusing on the indicator would mean missing the bigger picture that the price was under strong longer-term selling pressure.
Crossovers are another way that the indicator can be used. Watch for the conversion line to move above the baseline, especially when the price is above the cloud. This can be a powerful buy signal. One option is to hold the trade until the conversion line drops back below the baseline. Any of the other lines could be used as exit points as well.
Limitations of Using the Ichimoku Cloud
The indicator can make a chart look busy with all the lines. To remedy this, most charting software allows certain lines to be hidden. For example, all of the lines can be hidden except for Leading Span A and Leading Span B, which create the cloud. Each trader needs to focus on which lines provide the most information, then consider hiding the rest if all of the lines are distracting.
Another limitation of the Ichimoku Cloud is that it is based on historical data. While two of these data points are plotted in the future, there is nothing in the formula that is inherently predictive. Averages are simply being plotted in the future.
The cloud can also become irrelevant for long periods of time, as the price remains way above or way below it. At times like these, the conversion line, the base line, and their crossovers become more important, as they generally stick closer to the price.