FuturesTechs Blog

FuturesTechs has delivered seminars for 7 City Learning for many years, and their latest public course is on October 14th 2010.

This is a full days training with FuturesTechs’ Director Clive Lambert, introducing a wide range of Technical Analysis methods on a 1 day course at 7 City’s HQ in the City of London.

The day will give the delegate an overview of the Technical approach, different chart types (Candlestick charts in particular), support and resistance, chart patterns, gaps, Fibonacci analysis, Moving Averages, Momentum Indicators, and Market Profile.

A free copy of Clive’s book “Candlestick Charts” is included, as well as full colour course notes.

Please Click here for further details, and to book your place.

Ichimoku Charts are a tool many traders swear by, and which we may occasionally use as an ingredient in our daily analysis. This article explains the basics.

The main source I’m using will be “Ichimoku Charts” by Nicole Elliott, an excellent book which you can purchase from the Global Investor Bookshop by clicking here.

Part I: Construction

We start with the humble Japanese candlestick chart, the type that you will see on our reports every day. Replete with patterns, it is the building block of Ichimoku. Note that we generally only use daily charts for Ichimoku, although that’s more a product of convention than for any other reason.

Next, we add some special moving averages, with periods nine and twenty-six. These don’t use the close, as would normally be used in the West, but the “mid-price”, i.e. the price halfway between the high and the low of the period in question.

This mid-price is used to calculate each of the Ichimoku lines (except one) and is a convention passed on by the Japanese.  Similarly, the choice of 26 for the longer moving average is based on the length of the standard Japanese business month.

Now for some terminology: the nine-day moving average is called Tenkan-sen (the “Conversion Line”) while the twenty-six-day moving average is Kijun-sen (the “Base Line”). We can use these like we would any other pair of moving averages (see the previous blog tutorial).

Next, we add the defining feature of Ichimoku charts: the cloud. Here’s the complete picture:

The pink line at the top of the shaded cloud area in the centre of this chart is called Senkou Span A (”Leading Span A”), and is calculated as the average of the two special moving averages we had already added to the chart. As the average of two moving averages, it is thus a kind of weighted moving average, giving greater emphasis to the recent prices.

The other line forming the cloud is called Senkou Span B and is the average of the highest price of the last 52 days and the lowest price of the last 52 days. Since we aren’t necessarily expanding the 52-period range all the time, this regularly stays constant day-to-day (you can see how it has flat periods in the above chart).

Both of these lines are plotted 26 days ahead of the market. This means that for the current day, the positions of these lines are calculated using the data available 26 days ago. In other words, the current price is compared with what the weighted moving average and the longer-period range were 26 days ago, not what they are now.

Note also that the prices used here are the Japanese “midpoint” prices, not the close as might be expected in Western technical analysis.

The observant will notice that apart from the moving averages and the cloud lines, there is another line included in the chart above. This is the brown line (colours may vary) which is at the top of the chart during the middle of the pictured timeframe, and is the Chikou Span (”Lagging Span”). It is simply the daily close, plotted at a delay of 26 periods - hence why it “lags”. Each candle’s close, therefore, is plotted against the candle 26 days previously. Note that the Chikou Span is the only line in the Ichimoku chart which uses the closing price in its calculation.

Part II: Analysis

We can take Ichimoku Analysis to almost any level of depth, but the key ideas are as follows:

A. Moving Averages

These are used like the ordinary moving averages are used in traditional Western analysis: as support and resistance levels, getting a bullish message if the price is above the moving averages, or bearish if it is below. Also check for bullish/bearish crossover signals as the averages change position (see the previous blog article). A bullish crossover signal is stronger if it is seen above the cloud, while a bearish crossover signal is stronger if it happens below.

B. Ichimoku Cloud

We are bullish when the price is above the cloud, bearish when it is below.

We also use the cloud lines (Senkou Spans A and B)  as support/resistance levels, getting reversal signals when they are broken.

The width of the cloud doesn’t really matter, except insofar as a thicker cloud means that it will take longer for us to reverse skew by a breakout through the opposite side.

On a related note, the colour of the cloud doesn’t really matter either - it just tells us which line of the cloud is on top. In the above chart, red means that Senkou Span A is on top, while blue means that Senkou Span B is on top.

The Dow chart above would have had us thinking bear thoughts first of all as the price dipped below the cloud. Since it didn’t manage to get a close below it, however, we probably wouldn’t have sided with the bulls outright, still waiting for a clean move away from it. When the price soon rallied back above it, we could then have taken an outright bullish skew.

Hopefully, this skew would have been maintained for most of the period shown above. Of course, the candlesticks did give bearish reversal warnings at various points, and there were a couple of short-term corrections. The solution might be to use the candlestick patterns for specific short-term entry and exit points, while using Ichimoku for an insight into the big picture. For those who are investing for the medium to long term, they might ignore the short-term candlestick patterns completely, or use them merely to make small adjustments to their positions or as a minor piece of evidence relative to the longer-term Ichimoku cloud.

The lessons from this are familiar: use more than one indicator, be flexible, and always act appropriately with respect to your investment or trading timeframe.

C. Chikou Span

This last piece of the jigsaw is simply the close mapped 26 days previously. With this, we can check if the recent close is above or below the candle of 26 days ago, and use that as another piece of evidence.

The Chilkou Span is quite easily recognisable, no matter what colour it is on your chart, since it is just the line chart at a lag. We can see it spike upwards in the above when this market broke to the upside in September. It’s not complicated, of course, but simply knowing where you are in relation to the price last month is a useful piece of the jigsaw. It’s bullish if the Chikou Span is above the candle of 26 days ago, or bearish if it’s below the candle 26 days ago, and we get bullish and bearish signals as they change position.

Part III: Conclusion

We’ve explained Ichimoku charts in a nutshell. The cloud is the most important, and the most unique feature, with two lines: Senkou Span A, a moving average which gives greater weight to the more recent prices, and Senkou Span B, the midpoint of a long-term range. We’ll tend to be bullish above the cloud, and bearish below it. We’ll also monitor the action of two special moving averages and the lagged closing price (Chikou Span). There are a host of signals to watch out for, and our conviction to buy or sell is strongest when all of the signals are aligned.

For a more detailed exposition of Ichimoku Charts, see “Ichimoku Charts” by Nicole Elliott. To read the daily technical analysis we produce at FuturesTechs, sign up for a free trial.

Graham Neary MSTA (graham@futurestechs.co.uk)

One of the features we added when we made the free suite of levels is a collection of moving averages for each market we cover. These complement the pivot points and market profile levels which we had already been providing on a daily basis.

The moving averages are on 3 different timeframes: 10-day, 20-day and 50-day. We colour these numbers green when the 10-day is higher than the 20-day and the 20-day is higher than the 50-day, or red if the 10-day is lower than the 20-day and the 20-day is lower than the 50-day.

But why do technicians look at moving averages? The simplest way to put it is that the moving average is a smoothed trendline, and one of the most efficient ways of grasping the trend of any market. Unlike other technical tools (candlesticks and chart patterns, for example), the moving average is not designed to be an immediate predictor of future price action or key pivot points (though it does sometimes provide support and resistance levels). Instead, its job is to gives us a handle on the longer-term price direction. On the basis that trends tend to persist, aligning ourselves with this direction is usually to our advantage.

We use “simple” moving averages: this means that for the 10-day MA, for example, we simply calculate the average of the closing prices of the previous 10 days. There are other types of moving average (linearly weighted, exponential, etc.) which assign greater importance to more recent closing prices, or include data from all previous days using various different formulations for weighting the data, but the simple average remains the most commonly used.

As a lagging indicator, the moving average doesn’t react as soon as the price begins to trend, and it doesn’t reverse as soon as the trend changes course either. But in return for missing out on the exact start and finish of a trend, we get a measure of direction which doesn’t get knocked out by immediate fluctuations, helping us to stay true to the longer-term moves and resist trading too frequently.

There are a couple of variables which go into the makeup of the moving average. Apart from selecting which type of average to use, as already mentioned, we also need to choose the timeframe and the price to be entered into the calculation. While most people think that closing price is the most meaningful number as compared to the opening price or some other figure, there is no strong consensus about the choice of timeframe. The trade-off in this decision is between significance and responsiveness. A longer-period timeframe will certainly avoid being whipsawed and stay with the biggest moves, but it will also spend a great amount of time on the losing side when a trend changes course. A shorter-period timeframe will much better react to changes in trend, but will also get whipsawed more frequently and suggest more losing trades when there is a relatively weak trend.

One way to combine the best of both worlds is to use more than one moving average on the same chart. We can then look at moving average crossovers as buy and sell signals: when a shorter-term moving average crosses the long-term equivalent from below, we get a buy signal, and when it crosses from above, we get a sell signal.

This can work beautifully in markets with a well-defined trend. Using 10-week and 20-week moving averages to trade Brent crude oil, we would have got a buy signal on 19^th March, 2007 (closing price that day at $63.20), a sell signal on 25^th August 2008 (at $115.17), and a buy signal today (closing price somewhere around $52).

The problems arise in a trendless or choppy market, where the dangers of getting whipsawed increase and relying on moving averages can lead to ruination.

Suppose we tried to use 10-day and 20-day MAs to trade Brent crude in 2009, and in the most naïve way imaginable. How would it have worked out so far?

The horror show above doesn’t prove that these timeframes won’t work in the future (a rally from here could make the recent buy signal at $43.90 look inspired) but it does prove that they were the wrong timeframes to use over this trading period.

The lesson is that moving averages, as with any other indicator, must be used appropriately for the market under consideration, and in combination with other indicators and insights.

What we provide on our levels sheet are the 10-day, 20-day and 50-day MAs for the markets we cover, allowing members to get a feel for the price location in comparison to a decent selection of averages. As mentioned above, we point to the bullish or bearish alignment of these averages by highlighting them green when the 10-day is higher than the 20-day and the 20-day is higher than the 50-day, or red if the 10-day is lower than the 20-day and the 20-day is lower than the 50-day. Some traders who want to ride confirmed medium-term trends will wait for this kind of ultra-strong triple alignment before taking a position. The extreme case is when the price and moving averages are all aligned, and all moving in the same direction. Now that’s a trend!

But here’s a chart of the FTSE Index over the past 10 months, with the 10-day (red), 20-day (blue) and 50-day (black) MAs included, another example of the potential outcomes when using just one indicator:

Following the signals, and only closing out our positions when the moving averages turned to neutral, would have been great for the two downward moves in the first half of this chart. However, it also would have proved costly during the ranging market from November to January, which produced three false signals. To avoid being topped and tailed, we’d have to change the exit strategy during this time in order to take our profits much more quickly – something the moving averages will not help us to do. But the momentum of the averages should still be enough in most cases to ensure that the action continues in our direction for at least a few more points. Our level of confidence in the ability of the market to trend, combined with short-term indicators, should help to advise us on the correct course of action.

The point is that if you want to trade in the direction of a big trend, wait until you get the green or red highlights on our summary page. If the numbers are black, then there is simply no reason to get involved (at least, not from the point of view of the moving averages).

In the coming weeks and months we’ll be expanding the resources offered on our website to include exclusive files for our members covering new markets and new indicators. If there are particular markets or indicators you’d like us to cover, please let us know. For now, we hope you enjoy the levels sheet and find that the addition of the moving averages contributes to your successful trading!

Graham Neary (graham@futurestechs.co.uk)