Ichimoku Cloud Trading Strategy
Introduction
Even though the name implies one cloud, the Ichimoku Cloud is really a set of indicators designed as a standalone trading system. These indicators can be used to identify support and resistance, determine trend direction and generate trading signals. Ichimoku Kinko Hyo, which is the full name, translates into “one look equilibrium chart”. With one look, chartists can identify the trend and look for potential signals within that trend.
Strategy
Chartists use the actual cloud to identify the overall trend and establish a trading bias. Once a trading bias is established, chartists will wait for a correction when prices cross the Base Line (red line). An actual signal triggers when prices cross the Conversion Line (blue line) to signal an end to the correction.
This trading strategy will set three criteria for a bullish signal. First, the trading bias is bullish when prices are above the lowest line of the cloud. In other words, prices are either above the cloud or remain above cloud support. Second, price moves below the Base Line to signal a pullback and improve the risk-reward ratio for new long positions. Third, a bullish signal triggers when prices reverse and move above the Conversion Line.
As you can see, the three criteria will not be met in just one day. There is a pecking order to the process. First, the trend is bullish as defined by the cloud. Second, the stock pulls back with a move below the Base Line. Third, the stock turns back up with a move above the Conversion Line.
Buy Signal Recap:
Price is above the lowest line of the cloud (bullish bias)
Price moves below the Base Line (pullback)
Price Moves above the Conversion Line (upturn)
There are also three criteria for a bearish signal. First, the trading bias is bearish when prices are below the highest line of the cloud. This means price is either below the cloud or has yet to break above cloud resistance. Second, price moves above the Base Line to signal a bounce within a bigger downtrend. Third, a bearish signal triggers when prices reverse and move below the Conversion Line.
Sell Signal Recap:
Price is below the highest line of the cloud (bearish bias)
Price moves above the Base Line (bounce)
Price moves below the Conversion Line (downturn)
Conclusion
This Ichimoku Cloud system provides chartists with a means to identify a trading bias, identify corrections and time turning points. The cloud sets the overall tone and provides a longer perspective on the price trend. The Conversion Line (blue) is a relatively short-term indicator designed to catch turns early. Catching the turn early will improve the risk-reward ratio for trades. Keep in mind that this article is designed as a starting point for trading system development. Use these ideas to augment your trading style, risk-reward preferences, and personal judgments. Click here for a chart of IBM with the Ichimoku trading strategy.
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