7. Ichimoku Kinko Hyo in Forex Trading Strategy

Ichimoku Kinko Hyo is a Japanese investing technique. It provides all – trading signals, resistance and support levels. It is very different from normal western techniques such as trading with moving averages, but after a while you should understand it easily. It was created around 50 years ago by Japanese journalist Goichi Hosoda. He started to work on Ichimoku before World War II. To the West, this technique is known from 90s, just like candles it was unknown for many decades.
First, let’s see how Ichimoku is build. Later we will check how it can be used in trading stocks and Forex.

Ichimoku components

Ichimoku Kinko Hyo is build from 5 averages (notice – these are different averages than standard moving average that you know):

Senkou Span A and Senkou Span B – area between them is called Kumo, or simply just Ichimoku cloud. This is a resistance and support area
Kijun-Sen – longer signal average
Tenkan-Sen – shorter signal average
Chikou Span – this average is shifted back by 26 periods

So when we put this together, we’ve got a ready investing system:

ichimoku-forex-trading-1

Time to learn more about each component.

Kumo (Ichimoku cloud)

Usually, we look for support or resistance right at moving average or support line. Ichimoku cloud is different – it is area of possible resistance or support. The thicker cloud is, the stronger resistance or support should be at this place. If cloud is thin, than possible support/resistance should be weak:

ichimoku-forex-trading-2-kumo

When price manage to break out or break down from cloud, then this is a strong signal to take position, because it happens rarely:

ichimoku-forex-trading-3-kumo

Kijun-Sen

It is longer average, based on 26 periods. Let’s compare Kijun Sen and 26 moving average. As you can see, it acts different.
From my experience, I can say that Kijun Sen itself is a good resistance/support level.
You can compare Kijun-Sen with normal moving average:

ichimoku-forex-trading-4-kijun

Tenkan-Sen

It is shorter average. Based with Kijun Sen it gives signals to buy and sell (more on that later). When trend is strong, it can also act as support/resistance.

ichimoku-forex-trading-5-tenkan

Chikou-Span

The main idea behind Chikou Span is that it helps to compare current price with price from 26 periods before. The end of Chikou Span is the current price close. Based on that we know if the current sentiment is bullish (Chikou Span above price) or bearish (Chikou Span below price).

ichimoku-forex-trading-6-chikou

Ichimoku trading signals

We have few types of trading signals from Ichimoku based on Tenkan-Sen and Kijun-Sen cross.
There are also signals to open a trade when price break from the cloud. You will see all that in the examples and it should be clear.

Ichimoku trades examples

First, to get more comfortable with Ichimoku, let’s start from higher time frames, which are easier to
read and trade.

I like to invest with Ichimoku in longer time frames. It is great when you look for entry point, not so great when it comes to exit, but we will also deal with that.

What I look on chart is mostly breakout from cloud. For me this is the best signal from all you get from Ichimoku. I check history, few years back, to see how price reacted around cloud. Were there many good signals after cloud breakout? Sometimes price action for current stock is so specific that this does not work so well. Then I move to another stock. When history confirms that price works well with cloud, I make decision or not. I place stop usually below cloud.

Sometimes price is already above cloud and trend is getting stronger. Then I look at Kijun Sen and Tenkan Sen. If Tenkan Sen is above Kijun Sen, I have a confirmation of uptrend. Then I like to look for breakout from resistance. Drawing resistance and support lines is very important here. Remember – it is weekly chart so if there is a resistence line, say, from top from six months before, there is a big chance that price will respect that resistance. If it manages to breakout, then it is a good signal to go long. So in that case Ichimoku is like a background, but important one.

Adobe stocks, monthly chart

I do not follow signals blindly. So when there is a breakout from cloud, I check other things. Most important for me are trend lines. Monthly chart of Adobe is a good example. We had two breakouts from cloud which failed because of resistance lines. Finally price managed to breakout from cloud and resistance lines – this was a perfect moment to go long.

7.1. Long trade on break above cloud and resistance lines

7.1. Long trade on break above cloud and resistance lines

If trend is strong, then price is above Kijun Sen. This is my stop loss. I do not wait for Tenkan Sen and Kijun Sen cross to close position because this signal comes on most cases too late. Other technique you can use is to set stop loss below recent low. This will be your exit point.

City stocks, weekly chart

7.2. Break from the cloud

7.2. Break from the cloud

This is a little to perfect example of trade. I use very often breakout from cloud as signal to enter. In this example we saw a long breakout and price went up above 50$. Exit place was when price closed below Kijun Sen. It is not always that easy but it is rather a good example of potential this signal has.

Electronic Arts stocks, monthly chart

7.3. Adding oscillators to help decide if breakout is valid

7.3. Adding oscillators to help decide if breakout is valid

Problem with breakouts from cloud is that you may see some false breakouts. In the chart above the first long breakout was false, the second one was correct and trade should be closed above Kijun Sen.

You can try to add another condition to the breakouts from cloud. In this example, we used Williams %R to filter breakouts. The conditon is simple – %R should be in oversold or overbought area to enter trade.

On the right side we can see that it looks like another trade opportunity, with breakout from cloud and %R in oversold area.

EMR stocks, monthly chart

7.4. Example of different breakouts

7.4. Example of different breakouts

This trade worked great – long at cloud breakout and close below Kijun Sen, but… You can see on the left and right side that there were some breakouts, which did not bring strong trend. I would not call all of them false. Some worked out, but with smaller range of moves. That is why it is so important to manage wisely your stop losses.

ROST stocks, monthly chart

7.5. Signal to go long (break from cloud), stop loss would be below cloud

7.5. Signal to go long (break from cloud), stop loss would be below cloud

When cloud is thin, I place stop loss below cloud. In this case we took the first long breakout and set stop loss below cloud. Move up did not start rigth away, but ROST hold above cloud and is going up strong.

COP stocks, weekly chart

7.6. Open and close position based on Tenkan and Kijun lines

7.6. Open and close position based on Tenkan and Kijun lines

Sometimes the trend is strong and price will be far away from cloud, so no signals from cloud breakout. When you see a situation like that, you may use breakout below or above Kijun Sen as a signal.

First trade – after correction price returned above Kijun Sen (black). We got signal to go long. An exit was here below Tenkan Sen because we spotted that price is most of the time above Tenkan and Kijun is far away.

Second trade – same scenario. A long breakout above Kijun Sen and close below Tenkan Sen (because Kijun Sen was too far).