Get Your Head IN the Clouds
Dear Penny Stock Millionaire,
I’ve been getting a bunch of questions recently about various technical indicators, one in particular a question about the Ichimoku Cloud stood out to me. I don’t personally use the Ichimoku Cloud when I trade, but I want you to have the best information around, and give you any potential edge or tool I can to help you.
Everyone wants an edge in their trading right? We all want the answer. The one thing that’s failproof. The easy button.
Is the Ichimoku Cloud an easy button?
Here’s a big hint:
There is NO easy button. It doesn’t exist. If it did, you wouldn’t be here right now.
Everyone would know about it. Social media would be abuzz and everything would come to a screeching halt because we’d all have the answer.
But Tim, what’s up with traders who say they have the answer? Or those who say “this indicator is infallible.”
The short answer is a math whiz comes up with something they think works, and then they spend a lot of time telling you how to use it.
Then, right at the end of their lengthy explanation, they tell you to use it with another indicator… And basic support and resistance. Almost everyone tells you to use basic support and resistance.
There are literally dozens of technical indicators. Developed by people with a lot more math going through their brains than I care to think about. And every one of them comes up with something they think works. Then the real fun begins. They have to convince everyone else it works.
It’s easy to overcomplicate things. Especially if you’re looking for the easy button. Some people call it the shiny object syndrome. You learn about something and think you have to start using it. Then, before you’ve really had enough time to learn it, you just go for it.
Time takes time. And learning how to use indicators takes time. So if you do choose to use them, be willing to put in the time.
I’ll say it again. There is NO easy button.
What does all this have to do with the Ichimoku Cloud? You might decide the Ichimoku Cloud is the one technical indicator you need. Or you may take one look and say, “that’s too complicated for me.”
If you decide to use it, be willing to put the time in to really learn how it fits into your trading plan.
A Big Caveat About Technical Indicators (Make it Two)
I’ll assume if you are still reading you’re interested in adding more technical indicators to your toolbox, which isn’t a bad thing! But I have two caveats before you continue.
First caveat: If you’re a beginning trader, it’s best to focus on chart patterns and basic support/resistance. There’s enough to think about without adding layers of complexity.
Second caveat: technical indicators are just that — indicators. Take any individual article about how to trade using a technical indicator with a grain of salt. I’ll continue to point this out as I take you through the Ichimoku Cloud.
The Ichimoku is one of the most ‘action packed’ technical indicators going. It’s based on a simple moving average variation, but it uses five lines. It’s pretty crazy when you first look at it.
But it’s not super complicated, Once you wrap your head around it, it’s pretty straightforward. The question should be asking is, does it support your trading strategy?
What is the Ichimoku Cloud
The Ichimoku Cloud is sometimes called the Ichimoku Kinko Hyo. It uses several moving average variations to indicate support, resistance, and momentum. At first, it looks pretty scary. But once you spend some time with it and understand what you’re seeing it’s much like any indicator.
The Ichimoku cloud was developed by Japanese journalist Hosoda Goichi. He spent — get ready for this — three decades developing it as a way to improve his price forecasting.
Remember earlier when I said time takes time? Talk about dedication. Hosoda Goichi put in the time. He didn’t release his ideas to the world until the 1960s but he’d been at it since the ‘30s.
What are the lines in the Ichimoku Cloud?
Before you try trading using the Ichimoku cloud, you need to learn what the lines represent. It seems obvious, but it’s amazing how unprepared some people are when they start trading.
Unlike you. You’re here to learn.
Here’s a chart with the Ichimoku Cloud on it. This is Akari Therapeutics Inc (NASDAQ: AKTX). Back in March (the 14th to be exact) this stock spiked during pre-market trading. The entire chart is pre-market. I didn’t trade it but I was watching it. Since it was on my watchlist I thought I’d check it with the Ichimoku Cloud.
The first two lines are a variation of moving average. Instead of using closing price, they use high/low average within a period. Like regular moving averages, these two lines signal momentum because one is fast and one is slow.
- Tenkan-sen: this is often called the signal or conversion line. It calculates the average of the highest high and lowest low for the past 9 periods. (Like most indicators, the number of periods can be changed to tweak the Ichimoku Cloud.) It’s calculated like this: (9 period high + 9 period low)/2
- Kijun-sen: this is often called the confirmation or base line. Essentially, it’s a slower version of the Tenkan-sen. Kijun-sen is calculated like this: (26 period high + 26 period low)/2
Next come the span lines. These lines form the border of the cloud, or kumo. The span lines are perceived to act as support or resistance depending on their relationship to current price. In other words, if the current price is above the span lines, Ichimoku traders believe they act as support. If the current price is below, traders consider them resistance.
- Senkou span A is a moving average of the Tenkan-sen and Kijun-sen lines. It’s calculated like this: (Tenkan-sen + Kijun-sen)/2. It’s plotted 26 periods ahead.
- Senkou span B is calculated in a similar manner to the first two lines but for a longer period. It’s calculated like this: (52 week high + 52 week low)/2. It’s plotted 26 periods ahead.
Note that these calculations can (and do) lead to horizontal lines as part of the cloud. This is because the high and/or low of a given period might not change for several trading sessions.
The final line is the Chikou span. This is the only line based on closing price rather than a high/low average.
- Chikou span: this is often called the lagging span. It is calculated like this: period close plotted 26 periods behind.
Many traders ignore the Chikou span altogether. After all, it’s just the closing price projected backwards, right? Thing is, Hosoda Goichi spent three decades developing the Ichimoku Cloud. He must have had a reason for putting it there.
My take on it: Chikou span gives extra visual confirmation of possible support or resistance.
What Do All the Ichimoku Cloud Lines Mean?
Let’s take a quick step back and look at the big picture. Ichimoku Cloud is based on a variation of the simple moving average. So if you don’t understand moving averages …
… read my Moving Average Guide post.
In a nutshell, a lower number of periods used to calculate a moving average means a faster moving line. A faster moving line more closely follows the price. The conversion line is based on 9 periods and the base line is calculated using 26 periods. So, the conversion line moves faster. Which is why the blue line (Tenkan-sen) on the chart stays closer to price action.
The Kijun-sen (base line) — is slower. It smoothes out the data like a standard moving average.
The Senkou spans are the same. Span A is a moving average of the conversion and base lines. It moves faster than Senkou span B. Senkou span B is slower because it’s calculated using 52 periods. Remember, these two lines are projected forward 26 periods.
The Bottom Line
The Ichimoku Cloud is an interesting indicator. Is Ichimoku Cloud a legit way to trade? Absolutely, but that doesn’t mean that I use it to trade. Like any technical indicator, if you spend time and learn how it works it could be a nice addition to your bag of tricks.
It all depends on whether or not it fits your trading plan.
Editor, Penny Stock Millionaires