Ichimoku Cloud (Kumo) charting

Celticheart Investor

A beginner's guide to trading and investing

The Ichimoku Cloud (Kumo) chart, also known as the Ichimoku Kinko Hyo; Ichimoku meaning “One Look” is a modern Japanese charting system that (as it says on the tin) shows a lot of information at a glance, without the need for any other technical indicator, something that candlestick charts cannot do alone, relying on multiple supporting tools as we have seen in previous chapters. 

As with other Technical Analysis indicators the purpose of this system is to help us determine changes in market direction and trading signals. This system was developed by Goichi Hosoda, a Japanese journalist, and was published in 1969.

At first glance the Ichimoku Cloud looks complicated but if you take a little time to study it the simplicity of the system soon becomes clear, as you would expect from an indicator that was created by a journalist not an analyst.

Ichimoku Cloud shows us, in one easily accessible chart, probable future support and resistance levels as well as momentum and trend directions. Some of the elements we are already familiar with such as the moving averages, Tenkan-sen (Conversion line) and Kijun-sen (Base line) to show bullish and bearish crossover points, similar to that of the EMA 20 and EMA 50 (See chapter Eleven, Moving Averages).

The "clouds" (kumo, in Japanese) are the areas formed between spans of the moving average of the Tenkan-sen (Conversion line) and Kijun-sen (Base line), which are plotted six months ahead Senkou (Leading) span B and of the midpoint of the 52-week high and low (Senkou span B) also plotted six months ahead.

        

Analysis tells us that we are in an uptrend when the prices are above the cloud, and in a downtrend down when prices are below the cloud. When prices are within the cloud itself the market is seen as flat or indecisive.

Senkou span A crossing above Senkou span B indicates a strong uptrend, and just like candlesticks, is shown as a green coloured cloud (Kumo). Conversely when Senkou span B crosses above Senkou span A the trend is downwards and is shown as a red coloured cloud (Kumo).

Because the Cloud is projected 26 days in advance it can, unusually, provide us with a glimpse of future support or resistance.

The Ichimoku Cloud consists of five basic plots as explained below:

Tenkan-sen (Conversion Line): This is the 9 day high + the 9 day low divided by 2. The default span for this is 9 trading periods but can of course be adjusted

Kijun-sen (Base Line): This is the 26 day high + the 26 day low divided by 2. The default span for this is 26 trading periods but can also be adjusted to suit your trading strategy.

Senkou Span A (Leading Span A) is the average of the conversion and base lines, calculated with 9 and 26 trading periods, Senkou Span A (green) moves faster than Senkou B (red) much as EMA20 moves faster than EMA50.

Senkou Span B (Leading Span B): is the 52 day high + the 52 day low divided by 2. This is the mid point of the 52 day high and low trading range. Although the default setting for this is 52 periods it can also be adjusted. This value is also plotted 26 periods ahead, which is why it is referred to as a leading span.

Chikou Span (Lagging Span): This is plotted 26 days behind the current trading. The default setting is 26 periods, but as with the Senkou Span (Leading span) this can be adjusted to suit. Because this value is plotted 26 periods behind it is referred to as a lagging or trailing span.

For a more in-depth look at the Ichimoku Cloud system go to:

http://www.ichimokutrader.com/

http://www.investopedia.com/terms/i/ichimokuchart.asp

http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:ichimoku_cloud

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.

Patterns

Celticheart Investor

A beginner's guide to trading and investing

Understanding how individual candlesticks are formed is  one thing but how do we go about understanding their significance in the greater scheme of things?

Well the secret is quite simple really, like a lot of oriental based knowledge, it is all about recognising repeating patterns and their associated actions. By that I mean that if certain patterns are usually (not always) followed by certain market reactions then we can use those "triggers" to our advantage.

Charting patterns can, as I have previously explained fall into one of three categories, Bullish (buyers dominant), Bearish (sellers dominant) or Neutral (neither buyers nor sellers dominant). The problem is the strength of those signals vary in certainty from a weak signal (there might be a directional change) to a strong signal (there will almost certainly be a directional change). 
I say almost certainly because in the world of investing, especially in small caps there is no such thing as certainty, no matter who tells you there is.

Forgive me if I re-visit elements that I have already talked about but seeing them in isolation is not the same as seeing them in the context of a chart. 
So let's look at some examples of charts showing these repeating patterns:

This is an example of a candlestick chart for the Footsie 100, as you can see 
the change in direction is preceded by a spinning top or a hammer but the important thing to notice is the next bar which gives a confirmation of that change in direction. Interestingly enough the colour of the bar is less important than the formation of that candlestick.

This is a great example of how charting patterns repeat themselves, note the similarity in the MACD, the relative positions of the EMA20 dn EMA 50 and also 
the closing together of the Bollinger bands just prior to an uptrend.

Looking at individual reversal signals though is less effective than some of the patterns we have looked at previously. Learn to identify at least some these combinations for more accurate interpretation of the charts. This is just a sampling there are many more patterns to become aware of as you progress.
 

  


Apart from what we have already looked at here another pattern which we should look at, and are often regarded as being the most positive of reversal signals, so much so that you don't even have to wait for a confirmation signal
(if you are brave enough), they are called kickers and appear in both Bullish 
and Bearish variants.

In the bullish version, after three successive days of seller dominance the trend reverses on the fourth day with such a positive shift that it often forcing short sellers to close their positions with spectacular effect, the reverse happens in the bearish version of this strong signal.

One pattern that is well worth looking at is the "Bearish Tri Star Pattern", which is a very rare but significant top reversal pattern. It is formed by three Dojis. with the centre Doji being above the other two (called a Doji star).

For this signal to be valid the market has to be in an uptrend, the Dojis have to appear on three consecutive days. The second day Doji has to have a gap above the first and third Dojis.

The explanation for why this is so significant is that the fiest Doji indicates that the uptrend has stalled, the second shows that the market has lost direction and the third confirms indecision leading to a reversal.

To be sure that this is in act a reversal you should look for the fourth day as a confirmation signal, a black or red candlestick, a gap down or a lower close.


Next time: Confirmation

A cautionary note, trading and investing in shares carries a level of risk, these blogs are only meant as a basic guideline to investing and trading, always do your own research and base your decisions on what you can afford to lose. This blog is not intended to provide financial advice as I am not qualified to do so, it is simply designed to provide information about how the markets work that might be of some help to private investors like myself.