The Ichimoku Kinkou-Hyo is a technical analysis method that was developed by Goichi Hosoda before World War II. Most traders tend to call it just “Ichimoku,” as it is referred to within DealBook® 360, but the full name correctly translates to “one look at the equilibrium prices.”
This study measures midpoints of historical highs and lows at different points in time and several time lengths to provide support and resistance levels and entry and exit points. Approximately two decades after the Ichimoku method was developed, George Appel designed his famous Moving Average Convergence Divergence (MACD) indicator to find entry and exit points and gauge the momentum. Hosoda used three key time periods for its input parameters: 9, 26, and 52. Appel, in turn, used 9, 12, and 26. Given the similarity of the number of periods employed by Hosoda and Appel, a comparison is in order.
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Ichimoku Kinkou-Hyo
Analysts commonly refer to the Ichimoku Kinkou-Hyo as “the cloud,” but this is an incomplete approach. The Ichimoku method consists of five lines: trendline (Kijun), signal line (Tenkan), lagging line (Chikou), and the leading lines, or the cloud (Senkou Span A and Span B). The cloud is formed only by the last two lines.
Figure 1 shows the application of this method on the daily dollar/yen chart.
Figure 1. Application of the Ichimoku system and its five lines - trend line (Kijun), signal line (Tenkan), lagging line (Chikou), the cloud lines (Senkou Span A and Span B) - on the daily dollar/yen chart.
By selecting Ichimoku from the list of indicators available within DealBook® 360, you can apply this indicator over your chart, or in a separate subgraph. You can then customize the inputs or use the default settings for each of the lines within the Ichimoku indicator.
Let’s break this system down to better analyze how we can benefit from these lines.
Trend Line (Kijun)
Kijun line means trendline in Japanese, and traders are suggested to follow its lead. Therefore, a declining trendline gives a selling signal and a rising trendline provides a buying signal.
The formula for the trendline is calculated as follows:
Trend (Kijun) line = (highest high+ lowest low)/2 for the past 26 days
Figure 2 shows three clear phases of the uptrend: two down, marked by red arrows and one up, marked by a blue arrow. The trendline accurately provided direction, support and resistance. There was only one exception during the rising phase, in which the dollar/yen managed to break below the trendline and to trade beneath it for four full days. While this chart shows the trendline working well, remember that the trendline will work well only in trending phases.
Do not follow the trendline blindly. Even though it works well in this example, you can also notice the divergence between the dollar/yen and the trendline. When the price fell too far from this line in both the first and last phases, the dollar/yen always retraced. Conversely, when the dollar/yen rallied too far from the rising trendline during the middle phase, it always pulled back.
Standard trading rules apply, so a drop below the trendline suggests a sell and vice versa. Of course, only a close above or below the trendline confirms the breakout. So, even during the trend failure in the middle phase in March, a disciplined trader should have sold on the initial sell-off and covered when dollar/yen climbed back up above the trendline, even though the P&L was probably nil.
Figure 2. Application of the Ichimoku’s trend line (Kijun) on the daily dollar/yen chart.
To summarize, the trendline should not be used solely for direction, but also for identifying overbought and oversold conditions.
Signal Line (Tenkan)
The signal line (Tenkan) works best in conjunction with the trendline.
The formula for the signal line (Tenkan) is calculated as follows:
Signal line (Tenkan) = (highest high+ lowest low)/2 for the past 9 days
Figure 3 shows a combination of the signal (purple) and trend (green) lines. A move of the signal line above the trendline provides a buy signal (see the blue arrow) and a crossover below it gives a sell signal (marked by a red arrow).
Figure 3 shows a combination of the signal (Tenkan) and trend (Kijun) lines. An intersection of the signal line above the trend line provides a buy signal and a crossover below it gives a sell signal.
Both signals worked, but how was their timing? A closer look shows clearly that the intersections were late in providing the signals. Why? These lines are essentially moving averages and these lines are late. Let’s compare the crossovers between exponential moving averages on days 9 (the red line) and 26 (the blue line), and these two Ichimoku lines (green and purple). The crossovers of the averages were late in signaling the change in direction as well.
However, the timing of the two sets of intersections did not match. You can see a comparison of the crossovers of the Ichimoku’s Tenkan and Kijun lines and the 9-day and 26-day exponential moving averages in Figure 4.
Figure 4. A comparison of the crossovers of the Ichimoku’s Tenkan and Kijun lines and the 9-day and 26-day exponential moving averages shows that both sets of lines were late in providing timely entry and exit signals.
Lagging Line (Chikou)
The lagging line, or the Chikou line, is important for the Ichimoku system. The lagging line is simply the current close plotted 26 periods behind.
If both the lagging line and the currency price are rising, then this is a buy signal, and vice versa. Figure 5 adds the Chikou line to the Ichimoku’s Tenkan and Kijun lines.
Figure 5. Ichimoku’s Chikou, Tenkan and Kijun lines applied to the dollar/yen daily chart.
Furthermore, if a selling signal occurs while the lagging line is plotted below the current closing price, then this signal gains more technical strength. The opposite applies to a bullish market: if a bullish signal is formed while the lagging line floats above the closing line, then this signal is more important.
The Cloud (Senkou Spans A and B)
The two leading lines, or Senkou, form a cloud-like formation, which is called Kumo in Japanese. The cloud provides areas of support or resistance. The currency must break above the cloud to give a buy signal or below the cloud to provide a sell signal. The leading lines are used in a similar manner as the standard support and resistance levels.
Traders generally use the cloud for current support and resistance. However, the leading span lines are also plotted ahead of the market, so they can help forecast support and resistance in advance, and possibly direction as well. Naturally, markets above the cloud are generally in an uptrend, while those below the cloud are typically in a downtrend.
The leading lines formulas are calculated as follows:
Leading line A = (Tenkan line + Kijun line)/2, plotted 26 periods ahead
and
Leading line B = (Highest high + Lowest low)/2 for the past 52 periods, plotted 26 days ahead
Let’s look at only the cloud on the dollar/yen chart in Figure 6. Dollar/yen managed to smash the resistance of the cloud in the first instance, which is shown by the initial blue arrow. The pair attacked and successfully penetrated the support of the cloud in the second half of the chart, which is indicated by a red arrow. In the future, the failure to surpass the cloud resistance should translate into a severe sell-off.
Figure 6. The cloud (Kumo) is formed by two leading lines, or Senkou, which provide support and resistance levels.
As Figure 6 shows, the cloud has different levels of thickness. Generally, a thick cloud means good support or resistance and increased volatility. Conversely, a thin cloud tends to signal a period of low volatility, so the currency is expected to consolidate.
Relative Strength Signals
In addition to the intersection between the currency price and one or two of the individual lines, in sync moves and overbought/oversold conditions, the Ichimoku system provides more trading signals, which are known as relative strength signals.
A bullish crossover that occurs above the cloud formation will become a very strong buying signal, while a bearish crossover forming below the cloud will turn into a very bearish signal.
If the intersection occurs within the cloud, then the buy or sell signals are normal in significance.
Finally, a bullish crossover becomes a weak buy signal if formed below the cloud formation. Conversely, a bearish intersection loses technical significance if it occurs above the cloud.
Moving Average Convergence Divergence Indicator (MACD)
The MACD was developed by Gerald Appel to highlight entry and exit points and gauge the market with signals generated by diverging consecutive moving averages. This oscillator uses exponentially smoothed moving averages.
The MACD consists of two lines:
1. The difference between two exponential moving averages on 12-day and 26-day
2. A 9-day exponential moving average which acts as a trigger or signal line
Moving Average Oscillator = EMA12 - EMA26
where
EMA12 = 12-day exponentially smoothed moving average
EMA26 = 26-day exponentially smoothed moving average
The oscillator moves on an open scale around the zero line. By adding the MACD indictor to your chart within DealBook® 360, it can be represented on the as a line or as a histogram. You can also change the inputs for price and period.
The MACD gives buying signals when:
1. It rises above the zero line
2. The trigger line is above line that marks the difference between the 12-day and 26-day moving averages
3. There is a bullish divergence with the currency
Conversely, the MACD provides selling signals when:
1. It falls below the zero line
2. The trigger line falls below the difference between the 12-day and 26-day moving averages
3. There is a bearish divergence with the currency
As Figure 7 shows, the MACD provided two buying signals (blue arrows) and a selling signal (red arrow).
Figure 7. MACD applied to dollar/yen.
How do the Ichimoku and MACD work together? The chart in Figure 8 shows that the MACD is much faster in calling a change of direction relative to the crossovers provided by Ichimoku, but the cloud provides valuable support and resistance areas. So, when used together, these indicators should improve your performance.
Figure 8. Comparison between the Ichimoku signals and the MACD signals.
Duration
When Ichimoku was designed back in the 1930s, a trading week was six days long. These parameters therefore represent one and a half business weeks, one business month, and two business months respectively. Since the trading week is five, one may want to modify the parameters to 7, 22, and 44.
This suggests that the MACD parameters should be changed as well to 7 from 9, to 10 from 12, and to 22 from 26. In this case, the chart from Figure 8 would be slightly different in Figure 9.
Figure 9. Comparison between the updated Ichimoku signals and the MACD signals.
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