Trading with the Ichimoku Kinko Hyo

Trading with the Ichimoku Kinko Hyo

Introducing the Ichimoku Kinko Hyo

Trading with Ichimoku Kinko Hyo may sound like an educational course with a dai sensei or grand master, but Ichimoku Kinko Hyo is not a person; it is a technical indicator which was created in Japan, as the name may have given away. It has gathered quite a following and can easily be applied to trading charts, but most traders are likely to be very confused by this five-part indicator which measures momentum, identifies support/resistance levels, suggests potential future trend developments and offers plenty of trading signals along the way. This versatile indicator can be a gold mine of trading information and today we will take a closer look at what the Ichimoku Kinko Hyo looks like, along with some lessons in the Japanese language. After this, you will have a better idea what this indicator can do, how to use it and make an educated decision whether you want to implement it in your daily trading routine.

The Ichimoku Kinko Hyo, which is usually shortened to Ichimoku, was created in the 1930’s by Japanese journalist Goichi Hosoda who used the name Ichimoku Sanjin, which can be roughly translated as “What a man in the mountain sees.” Ichimoku translates to “one look”, and the idea behind this technical indicator was to give traders all the necessary information about an asset with just one look from one multi-faceted indicator. Most traders, especially those who lack the necessary experience, may have given Ichimoku one look and then dismissed it. Given the complexity of it, this hardly comes as a surprise. Kinko means “equilibrium” while Hyo refers to “chart”, therefore Ichimoku Kinko Hyo translates to “one look equilibrium chart.”

Goichi Hosoda worked on this indicator for over 30 years before publishing it in the late 1960’s, so plenty of research as well as trial & error has gone into creating this technical indicator. Ichimoku is a moving average based trend identification system, but many traders know it for the intense graphics which make any chart look smart; while the kumo or “cloud” created is unique to this indicator. There is a lot more information presented than in just a basic candlestick chart, which is also a Japanese creation from the 18th century by rice trader Munehisa Homma during the Tokugawa Shogunate; and traders who understand how to read charts can greatly benefit from Ichimoku. While Ichimoku was never translated into English, elements of its mathematical formula can be found in the following three theories: Time Theory, Wave Movement Theory and Target Price Theory. This again shows that learning comes before earning.

The composition of Ichimoku and the Ichimoku Kumo

Now let’s move past the history lesson and look at the five parts of Ichimoku. This technical indicator consists of the Tenkan-sen, the Kijun-sen, the Senkou Span A, the Senkou Span B and the Chikou Span. The Tenkan-sen is the conversion line; it is calculated by adding the intra-day high and intra-day low over the past nine trading periods and dividing it by two. The Tenkan-sen represents a key support or resistance level and alerts traders to potential reversals. Kijun-sen represents the base line and is calculated adding the intraday high and the intraday low over the past twenty-six trading days and dividing it by two. The resulting trend line also marks key support or resistance levels and additionally confirms a trend change; traders who use trailing stop loss orders often use Kijun-sen to make the necessary adjustments.

Senkou Span A is calculated by adding the Tenkan-sen and the Kijun-sen, then dividing it by two and shifting it by 26 periods into the future. This represents one part of the Ichimoku kumo which identifies potential future support/resistance levels of an asset. The second part is formed by the Senkou Span B which is calculated by adding the intraday high and the intraday low over the past fifty-two trading days, dividing it by two and shifting it 26 periods into the future. The area between the Senkou Span A and Senkou Span B is known as the Ichimoku kumo and the size of the cloud indicates the degree of volatility in price action. Chikou Span represents the current closing price, shifted 26 periods into the past in order to identify potential support/resistance levels.

How to Use Ichimoku for Better Entries & Exits

Now that we have learned about the history and composition of Ichimoku, as well as a little bit of Japanese, it is time to look at how this indicator can help you identify support and resistance levels, confirm trend changes and spot trading opportunities. 

Tenkan-sen: This is a trend indicator and shows traders in one look if the market is trending or ranging; the visuals speak for themselves. Buying an asset during an uptrend when price action is above the Tenkan-sen and selling in a downtrend when price action is below the Tenkan-sen means that trades are trading with the trend. This is a great sub-indicator for trend-following traders. A buy signal is generated when Tenkan-sen crosses above Kijun-sen, while a sell signal flashes when Tenkan-sen crosses below Kijun-sen; some traders act based on a close in price action above or below Tenkan-sen.

Kijun-sen: Where the Tenkan-sen indicates the current trend or lack thereof, Kijun-sen identifies the possible future trend of an asset. When price action trades above Kijun-sen, the trend is likely to extend further in that direction; the same applies when price action is located below Kijun-sen. This can assist the assessment of the magnitude of a trend extension and help with risk management. Traders may enter a buy order when price action closes above Kijun-sen and a sell order when price action closes below Kijun-sen.

Ichimoku Kumo: The Ichimoku kumo is formed by the Senkou Span A and the Senkou Span B. When an asset is located above the Senkou Span A, the top line of the Ichimoku kumo serves as the first support level and the bottom line, the Senkou Span B, as the second support level; if an asset is trading below the Senkou Span A, the bottom line forms the first resistance level and the top line the second resistance level. Besides highlighting current support/resistance levels, the Ichimoku kumo also points towards potential future support/resistance levels. A bullish kumo is formed when Senkou Span A trades above Senkou Span B while a bearish kumo is formed when Senkou Span A trades below Senkou Span B. Traders often look for crossovers of Senkou Span A and Senkou Span B in order to spot potential trend changes. 

Chikou Span: This lagging indicator is used to confirm support and resistance levels while trading signals are generated either by crossovers with price action or Tenkan-sen/Kijun-sen. The primary trading signal occurs when Chikou Span crosses price action from the bottom for a buy signal and if it crosses from the top a sell signal is generated. Alternatively, traders can wait for Chikou Span to cross either Tenkan-sen or Kijun-sen before entering a trade.

Styles of Using Ichimoku 

As you can see, Ichimoku is not just heavy on visuals; this technical indicator is packed with information for traders who understand how to read and interpret it. Besides information about the state of an asset, future guidance and trading signals, it can be a great tool when it comes to risk management. The Ichimoku kumo is often used with other aspects of technical analysis in order to confirm directional momentum. When using Ichimoku, the most accurate trading signals are generated in the direction of the trend; when price action is located above the Ichimoku kumo, look for buy signals, and when it is located below the Ichimoku kumo, look for sell signals.

While Ichimoku is a complex indicator, with experience, it becomes much easier to interpret and it represents a gold mine of information. It works best on longer time frames such as the daily or weekly, but some traders tweak it and learn how to use it on H4; since Ichimoku is based on moving averages, it is not well suited for shorter time frames. It provides accurate trading signals for the right trading strategy and trader personality; it also allows traders to quickly asses the current state of an asset, if it is in an uptrend, downtrend or ranging. Therefore, the name Ichimoku Kinko Hyo is quite accurate and so is the screen name used by its creator Goichi Hosoda; Ichimoku Sanjin or “What a man in the mountain sees” makes perfect sense, as a higher elevation will give you a much better overview of the bigger picture.

Cliff Wachtel is the author of The Sensible Guide to Forex, a book that is devoted to helping Forex traders trade intelligently, profitably, and for a long time. Cliff has studied the markets from many angles, and has earned first and advanced degrees in economics, finance and business. Throughout his career, Cliff has published market analysis and educational articles that have helped thousands of traders master the currency markets.