The best Ichimoku cloud strategy includes all elements of the Ichimoku indicator, and traders can use it as an individual profitable trading strategy.
Goichi Hosoda, who used to be known as Ichimoku Sanjin, developed this indicator in the late 1930s. The best thing about this indicator is that it provides a macro view of the price so that traders can read the market structure with an overall context.
In the following section, we will see what the Ichimoku cloud is along with its elements and how you can use it to trade in the forex market.
What is the Ichimoku Cloud?
The Ichimoku cloud or the Ichimoku Kinko Hyo is a famous trading indicator that consists of three lines and a cloud-based zone, based on the moving average function.
This indicator shows three dynamic levels that work as near-term support, resistance levels, and a cloud that works as a trend identifier. Before moving further about the trading strategy using this indicator, we will need to see how it looks like.
The image above represents the chart of USDJPY without any indicator. Let’s plot the Ichimoku cloud indicator in the chart to see how it looks like:
Many traders become confused to see this trading indicator as it looks like a mess. However, elements of this indicator represent the logic and a story. Therefore, if you understand this behavior, it would be a fantastic indicator for you.
Within this indicator, there are three moving average lines- blue, red, and green and a cloud consists of a zone with vertical lines.
In the next section, we will see what the element of these indicators is and how it forms.
If you have seen the image above, you would know that there are three dynamic lines and a Kumo cloud in this indicator.
The Kumo Cloud has an upper and lower level, which also works as a dynamic level. Therefore, we have five lines in the chart. All of these lines are calculated from the function of the moving average.
However, the calculation of Ichimoku Cloud is different from the traditional moving average calculation. The default parameter of this trading tool is 9, 26, 52, which is changeable from the setting of the indicator.
In the following section, we will see a closer look at elements of this indicator to get a proper understanding of it.
A green line represents the Chikou Span. If you attach the indicator in the chart, you will see the Chikou Span is at the same level as the current price but 26 periods earlier. Therefore, the Chikou Span is considered as a lagging component of the indicator.
A red line on the Ichimoku Indicator represents the Tenkan Sen. It is considered the moving average function known as the conversion line. It indicates the midpoint of the last nine candlesticks using the formula that is mentioned below:
Tenkan Sen= [(9 period high + 9 period low)/2]
The blue line on the theme of indicators represents the Kijun Sen. It is also considered the moving average function and known as a baseline. It indicates the midpoint of last 26 candlesticks using the formula that is mentioned below
Tenkan Sen= [(26 period high + 26 period low)/2]
Look at the image below to see a visual representation of these elements:
The “Cloud” (Senkou Span)
The cloud is a barrier that is shown in the chart. There is an upper and lower level in the cloud, known as Senkou Span A and Senkou Span B.
- Senkou Span A- It is known as the Leading Span A, which is the midpoint of the Conversion Line and the Base Line. It is a faster cloud as its value is plotted 26 periods into the future.
- Senkou Span B- This is known as the Leading Span B, which is the midpoint of the last 52 prices bar. It is a slower cloud as its value is plotted 52 periods into the future.
Ichimoku Cloud Indicator Strategy to Trade Forex
If you read the above section, you probably know elements of Ichimoku Cloud. In this section, we will see how to use Ichimoku Cloud to trade in the forex market, that you can use as a Ichimoku cloud day trading strategy or a swing trading strategy.
#1 Identify Trend Using the Ichimoku Cloud
By using the Ichimoku Cloud, we can filter the long-term and short-term movements.
- If the price is below the Cloud, the overall trend is down.
- If the price is above the Cloud, the overall trend is up.
- The Bullish and Bearish trend will continue until the market moves to a range.
- If the price approaches the Cloud, it may work as a support and resistance level.
If you trade with your trading strategy, you can understand the market trend as most of the retail trading strategy works well when the price goes through a trend.
Otherwise, you can use it as an individual trading strategy that will be seen in the following section.
#2 Tenkan Sen and Kijun Sen Buy Signals
The Tenkan Sen and Kijun Sen are the fastest moving elements of the Ichimoku cloud that provide early momentum signals. The image below represents how we can use the Tenkan Sen and Kijun Sen line to give a trading signal.
- At first, we should identify the price above the Cloud for a buy signal
- If the Tenkan Sen crosses above the Kijun Sen line, it will indicate a bullish signal. Furthermore, if the price moves above both lines, it will confirm the bullishness. Later on, the price will come down to the Tenkan Sen and Kijun Sen line to find dynamic support. We will enter the market as soon as the price rejects the dynamic levels with a candle close.
#3 Tenkan Sen and Kijun Sen Sell Signals
The image below represents how we can use the Tenkan Sen and Kijun Sen line to provide a trading signal in a bearish market.
- At first, we should see the price below the Cloud for a sell signal
- If the Tenkan Sen crosses below the Kijun Sen line, it will indicate a bearish signal. Furthermore, if the price moves below both lines, it will confirm the bullishness. Later on, the price will move up to the Tenkan Sen and Kijun Sen line to find dynamic support. We will enter the market as soon as the price rejects the dynamic levels with a candle close.
RSI with Ichimoku Cloud
In the above section, we learned about how to use Ichimoku Cloud as a forex trading strategy. Furthermore, We can combine RSI to create a confluence with these two indicators to increase this trading strategy’s accuracy.
You can use any indicators from the oscillator class, but we will use RSI as it works well with the Ichimoku indicator.
Traders may find it challenging to identify when the trend will end, and the reversal will start. We can use RSI to determine the oversold and overbought zone.
As we know, the RSI moves from 0 to 100 level; we can identify possible reversal zones by watching the top and bottom of these levels.
- RSI is above the 70 levels indicates that the price is at an overbought zone.
- RSI is below the 30 levels suggests that the price is at an oversold area.
Furthermore, if the price moves away above or below the Tenkan and Kijun Sen line, there is a possibility of market reversal as a gravitational force.
In this market condition, any divergence between the price and RSI will increase the likelihood of price reversal.
In the image above, we can see that the price moved down and formed a divergence between the price and RSI. Furthermore, the RSI was below the 30 level, which is also a potential price reversal signal.
Stop Loss and Take Profit Set
The stop loss and take profit set is similar to other moving average based trading strategies. However, the exit levels would be different based on traders’ personalities.
- Stop loss would be below or above the rejection candle from the Dynamic Tenkan Sen and Kijun Sen. Use 10-15 pips buffer in the stop loss level to avoid unusual market volatility.
- The conservative exit: Exit the trade once the Tenkan seniors and Kijun Sen move into the opposite direction of the current trend.
- The aggressive exit: Exit the trade when the price breaks the Cloud in the opposite direction.
Ichimoku cloud trading strategy is straightforward and easy to use that considers the overall market context.
You can follow the Ichimoku cloud trading strategy that is explained above as a swing trading or ichimoku cloud day trading method.
Furthermore, you can add other trading tools like support/resistance level, nature of the trend, price action, and chart patterns to increase the volatility.
To sum it up, here are the critical things that we should know about the Ichimoku Cloud trading strategy:
- Elements of Ichimoku Cloud Indicator are- Tenkan Sen, Kijun Sen, Senkou Span A, Senkou Span B, and Chikou Span
- If the price is below the Kumo Cloud, the overall trend is down I
- If the price is above the Cloud, the overall trend is up.
- Rejection from the dynamic Tenkan Sen and Kijun Sen line creates the possible buying and selling opportunity.
- Use the Oscillator to increase the probability of trend and identify the potential reversal zone.
- You can combine the Ichimoku Cloud with support, resistance, price action, and candlesticks to increase the trading possibilities.
The whole concept of ichimoku cloud explained in the above section. However, we know that the forex market consists of volatility, and there is some uncertainty in the market where some A+ setup might go wrong.
Therefore, you need to make sure that you are using a reasonable risk: ratio per trade to remain overall profitable.
Furthermore, do not risk the money that you are not capable of losing; otherwise, it will create additional mental pressure that might lead to making wrong trading decisions.