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Technical Analysis Tutorial: Ichimoku Charts

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)