How to use Ichimoku Cloud? 一目均衡表

How to use Ichimoku Cloud?

This is a continuation from the previous post on WHAT is the Ichimoku Cloud. In this series, I will be sharing on HOW to use the Ichimoku Cloud. Since this post is more lengthy and technical, it is recommended that one should at least have a basic understanding of the 6 components in Ichimoku Cloud before delving further. The list is not exhaustive and I will only cover strategies within the Ichimoku Cloud indicator. Though, it could also be used in conjunction with Fibonacci retracement, Elliott Waves, RSI Index, MACD, fractals etc.

Ichimoku Cloud is supposed to be a one glance one kill method. From one look one should be able to understand an overview of the market whether it is uptrend or downtrend, whether to get in, get out, where is resistance and support etc.

One Glance, just as anything in life, takes a decent amount of practice before the concepts and principles really sinks in. But with consistency and disciplined to MASTER Ichimoku cloud well, everything else you read would eventually become second-nature to you. So let’s see how are we going to do that? Here are some of the common ways to interpret the Ichimoku Cloud indicator.

1. Price position relative to Kumo cloud

DJIA Index: US bull-run market (Uptrend)
Shanghai Composite: China’s bear market in 2018 (Downtrend)

This is the most straight-forward method. Simply observe if prices are closing above cloud, inside cloud or below cloud? Similar to an airplane, if a plane is soaring high above the clouds, it’s a strong bullish uptrend. If the plane is flying through the clouds, it’s experiencing turbulence and clarity of vision is blur. If the plane is below clouds, it probably means the plane is about to do a landing soon.

Remember, the kumo cloud is a leading indicator that is made up by a combination of Senkou Span A and Senkou Span B. If prices are ABOVE cloud, it simply means that CURRENT prices are HIGHER than the mid-point price of the long-term bias indicator (Senkou Span B) and the mid-point price of the short/medium-term bias indicator (Senkou Span A).

If prices are BELOW cloud, it simply means that CURRENT prices are LOWER than the mid-point price of the long term bias indicator (Senkou Span B) and the mid-point price of the short/medium-term bias indicator (Senkou Span A).

I use the term “short/medium” bias for Senkou Span A because it is the MID POINT price of the short term indicator (Tenkan-Sen) and the medium term indicator (Kijun-Sen).

2. Thickness of Kumo Cloud

DJIA Index: Price action when it hits Thick cloud vs Thin cloud

The thickness of kumo cloud can tell us a couple of things: Strength of support/resistance, Volatility and Trend Reversals. As discussed previously, the Kumo cloud can be used as a level of support/resistance (In particular, the 3rd and 4th line of defense). The thicker the cloud, the harder it is for price to penetrate through upwards or downwards. The thinner the cloud, the easier it is for price to break-through upwards or downwards. Similar to flying an airline, if there are a lot of thick dense clouds in the atmosphere its harder to break past and it would probably experience some turbulence. But if there are barely any clouds, it would fly pass through it effortlessly without any resistance.

The above image illustrates a perfect example on thickness of cloud. Notice price consolidates for a period of time in the thick green cloud and it fails to break downwards. But price easily shoot upwards in the red thin cloud as if there is no resistance.

Thickness of cloud also gives us a clue on the market’s volatility. The thinner the cloud, the lower the volatility and the thicker the cloud, the higher its volatility. If we think about it, the distance between Senkou Span A and Senkou Span B is what gives the appearance of whether the cloud is fat or thin.

If the distance is FAR apart, it simply means prices are trading way above or below the long-term equilibrium price (high volatility). If distance is very near, it means prices are trading very closely to its long-term equilibrium price. (low volatility)

Bitcoin months of low volatility before breaking down

Generally, periods of low volatility is followed by periods of high volatility. The reason is because market is still consolidating and indecisive during periods of low volatility, but once a clear direction and momentum is set, herd mentality follows and prices would burst either upwards or downwards to continue the trend.

Those who knew Bollinger Bands might be familiar with the term Bollinger Band Squeeze. Bollinger squeeze simply means the standard deviations between the upper band and lower band becomes smaller and smaller before bursting through upwards/downwards. However, the original idea of volatility squeeze first appeared in Ichimoku Clouds before Bollinger Bands are invented in the 80s.

The above image of BTC chart shows how volatility squeeze works. Look how small the candles are (almost negligible to be seen). Volume and volatility is extremely low and this happens for a couple of months. But look what happened after the TK crossover and Kijun-Sen crossover (covered below in this post). High volatility resumes. *Observe how kumo clouds were extremely thin, but once a clear direction is set, clouds immediately fattens.

3. The Kumo Twist (Trend Reversal)

DJIA Index: 2008 Recession

The kumo cloud serves as a leading indicator and its like our future eye. It can peer through into the future and estimate what prices would be OR if a trend reversal is coming. If the cloud gets thinner, it means short/medium-term bias indicator is losing steam. If the cloud gets thicker, it means short/medium term bias indicator is adding steam, current trend is getting stronger and momentum is increasing.

In an uptrend, If a cloud becomes thinner or starts converging (Senkou Span A sloping downwards to cross over Senkou Span B), it simply means the market is not making higher highs anymore. The crossover of Senkou Span A BELOW or ABOVE Senkou Span B is known as the “Kumo Twist”. The kumo twist is when its cloud changes from green to red or vice versa. It is an indication that trend has weakened or a trend reversal is coming. But how does it work?

If the market high starts decreasing, then Tenkan-Sen and Kijun-Sen would start sloping downwards since the mid-point price is now lower. Senkou Span A is nothing but the addition of Tenkan-Sen and Kijun-Sen / 2. Hence, if Tenkan-Sen and Kijun-Sen decreases, Senkou Span A would also start decreasing. When Senkou Span A starts decreasing, the upper boundaries of the cloud would start compressing and cloud would becomes thinner. This indicates market weakness. Momentum and strength of trend has slowed down, people have stopped buying and market fails to make higher highs anymore.

If Tenkan-Sen, Kijun-Sen continues on decreasing, Senkou Span A would also follow along decreasing and ONCE Senkou Span A crosses BELOW Senkou Span B, it means it has officially entered into the bearish territory. Prices are BELOW the mid-point price of the past 52-period and its a 50% retracement from the 52-period all time high.

Sometimes market correction happens and buying volume comes in and that’s fine. OR sometimes, if price falls further down to a 61.8% retracement, the Fibonacci traders would jump in and push price back upwards. BUT if the cloud gets thicker and fatter as seen in the above diagram during the 08 crisis, it means selling pressure is high and the market might be facing a recession instead of correction.

4. Kumo Breakout

DJIA Index: Kumo breakout in 08 recession before recovering in 2010

Kumo Breakout is another common strategy used and its a powerful one. It simply means when prices CLOSE above cloud, a strong bull run is coming AND if prices close BELOW the cloud, a strong bear run is around the corner. I use the word “strong” because price has penetrate through the LAST line of defense.

To really understand this, always know that in Ichimoku cloud, there is 4 layers of defense. Tenkan-Sen > Kijun-Sen > Senkou span A > Senkou span B. That means, for prices to GET OUT of a bear market, it has to BREAK through the Tenkan-Sen > Kijun-Sen > Senkou Span A followed by Senkou Span B. When prices have gained sufficient interest, volume and momentum to close ABOVE Senkou Span B, that is a Bullish Kumo Breakout!

Vice versa, the END of a bull market is near when prices BREAK through below the Tenkan-Sen > Kijun-Sen > Senkou Span A and the last line of defense Senkou Span B. If selling is too heavy and prices close BELOW Senkou Span B, that is a Bearish Kumo Breakout!

5. Magnetic Flat Kumo

STI Index: Flat Kumo forms a STRONG resistance level
STI Index: Flat Kumo (Resistance turned Support turned Resistance)

What is a flat Kumo? Flat Kumo refers to the Senkou Span B, NOT Senkou Span A. I have briefly discussed in the previous post why Senkou Span B remains flat relatively longer than Senkou Span A. The higher your time-frame the more likely you are going to see flat Kumo around. The reason is simply it’s HARDER to make a higher high than the 52-period price OR a lower-low than the 52- period price.

Imagine on a monthly time frame, your price must break HIGHER than the highest price ever recorded in the past 4.3 years (52-month) before it starts sloping upwards. If prices continue to trade below the 4.3 years high and above the 4.3 years low, Senkou Span B would remain flat throughout.

In an uptrend, Senkou Span B is a flat BOTTOM kumo acting as a support. In a downtrend, Senkou Span B becomes a flat TOP kumo acting as a resistance. The longer the flatness of the Kumo, the more powerful is its support/resistance level and the more powerful this Kumo MAGNET becomes! Think of flat kumos as magnet, powerful magnets. That is to say, price would eventually be PULLED back to the equilibrium in the long-run.

Flat Kumos form very strong resistance or support levels, notice how when prices reaches the horizontal resistance of the flat kumo, it bounces away? It’s like a THICK cloud hovering above you.

Another reason why Flat Kumo forms very strong resistance or support levels is because its the Senkou Span B! It’s the long-term bias indicator. And the longer the flatness remains, it means the harder it is for price to breakout above or below it. (*If not, it wouldn’t have been flat for a long time).

This is how i would use flat kumos. Observe price action when its approaching a flat kumo resistance level. Notice if candle body is getting smaller, if yes it means its time to sell as that indicates decreasing buying volume and momentum. Similarly, if prices are being pulled down by a powerful kumo magnet below, observe if candle body is getting smaller, if yes it means its time to buy as that indicates decreasing selling volume and momentum. Entering at the all-time low long-term price provides you with a comfortable margin of safety.

6. Tenkan-Kijun Crossover (TK Crossover)

Tenkan-Sen is the fastest line (9 period moving average) and Kijun-Sen is the slower line (26 period moving average). When Tenkan-Sen crosses ABOVE Kijun-Sen, its a bullish signal and when Tenkan-Sen crosses BELOW Kijun-Sen, its a bearish signal. This is otherwise known as the “TK Crossover”. A crossover simply means the short-term price (9-period mid-point price) is higher or lower than the medium-term (26-period mid-point price) price.

However, knowing WHERE the TK crossover occurred is equally important. If bullish TK crossover happened ABOVE the kumo clouds, it’s a strong bullish crossover. If it happened INSIDE the clouds, it’s a neutral bullish crossover and if it happened BELOW the clouds, it’s a weak bullish crossover.

The same applies for a bearish TK crossover, that is when Tenkan-Sen crosses BELOW Kijun-Sen. If the bearish TK crossover happened ABOVE the kumo clouds, it’s a weak bear, if it happened INSIDE the clouds, it’s a neutral bear and if it happened BELOW the clouds, it’s a strong bear.

Think of it this way. The region ABOVE kumo clouds is a bullish region and the region BELOW kumo clouds is a bearish region. a bullish crossover in a bullish region is like a tailwind further pushing the trend up. Likewise, a bearish crossover in a bearish region is like adding fuel to fire, further pushing the trend lower.

Let’s see some examples to have a clearer understanding of what all these means. There are 6 possible scenarios in a TK crossover.

Bearish TK crossover in Bullish region (Above Kumo Cloud)
Bearish crossover in Neutral region (Inside Cloud)
Bearish TK crossover in Bearish region (Below Kumo Cloud)
Bullish TK crossover in Bullish region (Above Kumo Cloud)
Bullish TK Crossover in neutral region (Inside Kumo Cloud)
Bullish TK crossover in Bearish region (Below Kumo Cloud)

Do you notice something in the 6 scenarios? If the bullish TK crossover happened above clouds, look at how powerful the bull run is. Then compare the bullish TK crossover below clouds, price are unable to do a Kumo breakout. Observe the bearish TK crossover below clouds, look at how massive the bear is. Then compare the bearish TK crossover above clouds, it can’t break down below the cloud!

To summarize, a bullish TK crossover in a bearish region OR a bearish TK crossover in a bullish region counteracts and dilutes the trend’s strength and momentum.

7. Kijun-Sen Crossover

STI Index: Kijun-Sen crossover

STI Index: Kijun-Sen crossover

Kijun-Sen crossover, as the name implies, is simply when prices CROSSES above or below the Kijun-Sen line. Kijun-Sen is our medium-term bias indicator that measures the mid-point price of the past 26 periods. Hence, prices that manage to cut through the Kijun-Sen is a strong signal that trend reversal is around the corner.

The Kijun-Sen crossover is a simple, powerful and reliable technique but sometimes it can give false signals. Meaning price cross below Kijun-Sen BUT went up after a few periods OR price cross above Kijun-Sen BUT went down after awhile. A higher time-frame would reduce the occurrence of false breakouts and increase the reliability of Kijun-Sen. I personally like to evaluate Kijun-Sen cross on the weekly or monthly time-frame rather than a daily time-frame.

Similar to the TK crossover, the Kijun-Sen crossover can happen above cloud, inside cloud or below cloud. a bullish crossover ABOVE cloud is a strong bull signal and a bearish crossover BELOW cloud is a strong bear signal.

8. Chikou Span Position

Using Chikou Span to compare price on 27 Dec and price 26 periods ago

We have briefly covered this in the first part of this Ichimoku series. Chikou Span is the current price PUSHED back 26 periods before. Why did Ichimoku created this “Chikou Span”? The reason is because it allows you to compare current price with previous price. In an uptrend, price should make higher highs and in a downtrend, price should make lower lows. If your Chikou Span is floating around the candles, that means price today and price 26 periods ago is the same and market is still consolidating.

If Chikou Span is higher than the price 26 periods ago, that’s good news it means prices today is higher than that of 26 periods ago and its an uptrend (price makes higher high).

Likewise if Chikou Span is lower than price 26 periods ago, that means its likely to be a downtrend as prices today is lower than that of 26 periods ago. (price makes lower low).

Let’s try it out. Referring to the above diagram, price on 27 Dec 2018 is 22,480. But price 26 days ago on 16 Nov 2018 is 25,460. Probably not a good sign of a bull-run since prices are NOT making higher highs anymore. Might be a correction, might be start of a bear market, could be anything but all we know is price today is LOWER than price 26 days ago.

9. Using Chikou Span to plot Support/Resistance Levels

DJIA Index: Resistance and Support levels of DJIA

Chikou Span also act as a support/resistance level. It is MUCH easier to draw horizontal support/resistance lines on the Chikou Span rather than on the candle sticks. It can be confusing sometimes if you don’t know whether to draw support/resistance line on the closing body or the wicks. note that Chikou Span can only draw horizontal support/resistance lines. Drawing trend lines doesn’t work as the position is completely different from the candles.

We can see easily identify the next support level of the DJIA which is around 22,200, then 21,000, followed by 20,000 and 18,000.

10. Chikou Span Breakout

Using Chikou Span as a confirmation

This strategy is less commonly used as compared to observing whether Chikou Span is above or below price. But what many don’t know is that it provides a very strong confirmation in addition to other indicators. Chikou Span breakout is the Chikou Span breaking out from the Kumo clouds. It’s exactly the same as a kumo breakout just that instead of price, now we are using the Chikou span line.

If we look at the above chart, notice that price has already break BELOW kumo cloud. If you rely on the strategy of Kumo breakout alone it’s a sell signal, but if you look at Chikou Span it has not broken BELOW cloud yet! Chikou Span is still hanging around Senkou Span A or cloud support. If you used Chikou Span + Kumo breakout together, then you wouldn’t have sell just yet. That’s how Chikou Span is used as an additional confirmation and its so powerful but yet often overlooked.

If Chikou span is just price pushed back 26 periods before, then what’s the difference between a kumo breakout and Chikou Span breakout you might ask. This gets really confusing but if you understand it, you will realize the power of Chikou Span breakout.

Observe the diagram above. Let’s look at the Kumo breakout on the right first. Kumo breakout as we have discussed is when price breaks ABOVE or BELOW the cloud. Since cloud is a leading indicator, the cloud as at 24 Dec 18 is PROJECTED based on price action 26 weeks ago on 25 June 2018.

It is essentially saying price of long-term bias indicator should be Senkou Span B and price of short/medium-term bias indicator should be Senkou Span A. But now prices are BELOW ALL the short, medium and long-term PROJECTION of prices made 26 weeks ago. That’s a kumo breakout understanding.

Now let’s look at the Chikou Span breakout on the left. Chikou Span is prices today on 24 Dec 18 PUSHED back 26 weeks ago to 25 Jun 2018. Now let’s look at the cloud at Chikou Span line. Chikou Span breakout is when the lagging span breaks ABOVE or BELOW the cloud. The cloud at Chikou Span is also PROJECTED based on price action 26 weeks ago in 25 Dec 2017.

Chikou Span breakout can be interpreted as my price 26 weeks ago BREAKOUT from the cloud projections made 52 weeks ago. Kumo breakout can be interpreted as my price today BREAKOUT from the cloud projections made 26 weeks ago. If we combine both parts together, essentially it means prices today break through cloud PROJECTIONS made 26 weeks ago AS WELL AS 52 weeks ago. That’s the reason WHY Chikou Span breakout is used as an additional confirmation.

12. Going long/short using Ichimoku

Now that you have understood how each strategies work and how to interpret each of them. Here’s a useful checklist you can use in deciding whether to go long or short.

Going Long:
First, prices must be ABOVE kumo cloud
Second, cloud 26 periods ahead MUST be green.
Third, Bullish TK crossover occur ABOVE kumo cloud
and lastly, Chikou Span must be ABOVE cloud.

Going Short:
First, prices must be BELOW kumo cloud
Second, cloud 26 periods ahead MUST be red.
Third, Bearish TK crossover occur BELOW kumo cloud
and lastly, Chikou Span must be BELOW cloud.

Summary

Phew…pretty long post. Alright, we have pretty much covered all the basic strategies on HOW to use and interpret the different components of Ichimoku Cloud. This is one of the longest post I have ever written because I have to show different charts to illustrate the examples better. Let’s try to summarize and recap what we’ve covered.

First and foremost, the most obvious is to observe if prices are above, inside or below cloud. Above = Uptrend, Inside = Consolidation, Below = Downtrend.

Second, we can observe the thickness of the clouds. Thick clouds means high volatility, strong support/resistance and thin cloud means low volatility, weak support/resistance.Periods of low volatility are often followed by periods of high volatility. Then we know if cloud turns from thick to thin, it means reversals might be round the corner.

When clouds turn from thick to thin, its often the early signals of a Kumo twist. A Kumo twist could be trend reversals and it is when clouds turn from green to red or vice versa.

Third, Kumo breakout. There are 4 layers of defense in Ichimoku and when the last line of defense is broken, that’s a kumo breakout. But to gain additional assurance about a kumo breakout, we can use Chikou span breakout as that measures previous price against projected cloud 52 periods ago.

Fourth, we should be aware of Long flat Kumos. Flat kumos are MAGNETS and these levels are strong resistance/support zones.

Fifth, TK crossover. This is when the Tenkan-Sen crosses over Kijun-Sen and its simply the short-term price going ABOVE or BELOW the medium-term price. If Tenkan-Sen crosses above Kijun-Sen, its bullish and if it crosses below, its bearish. Knowing where TK crossover occurred is equally important. Did it happen above clouds, inside cloud or below cloud?

Sixth, Kijun-Sen crossover is simply prices cutting above or below the Kijun-Sen line. This indicator is simple and reliable because it measures the medium-term bias price action. Similarly to the TK crossover, knowing where Kijun-Sen crossed is equally important. Did it happen above clouds, inside cloud or below cloud?

Seventh, Chikou-Span is our lagging line and we can compare it with prices 26 periods ago to let us know if market is making higher highs or lower lows. Apart from that, we can also use Chikou-Span to draw horizontal support/resistance levels and use it to confirm a kumo breakout.

Lastly, and probably the most important point, is that Ichimoku Cloud is used for a TRENDING market. If its a consolidation market, don’t use it. If prices are inside cloud for a long time, stay out of it! Imagine you are a pilot and your plane is inside the clouds, your vision clarity becomes poor and your judgement would be affected. There is a lot of turbulence, false breakouts, false signals and its dangerous. Only when you see clear uptrend or clear downtrend would Ichimoku be more effective. Since this post is too long, I will do a separate analysis on the US, China and SG stock market using Ichimoku Cloud. Keep a lookout for the next post!

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