With all of the different indicators that can be used to trade stocks, it can sometimes be hard to figure out which ones to include in your trading system and which ones to dispense with.
But what if you could just use one indicator that was an entire trading system in itself? The Ichimoku Cloud indicator is designed to do exactly this.
But how can you trade with Ichimoku cloud? Read on to find out.
The four parts to Ichimoku
The first part of Ichimoku Cloud to pay attention to is the cloud itself.
When the price is above the cloud, it means that there is strong upward momentum. This is a time to look for long entries. If the price is below the cloud, it is time to look for short positions instead.
In addition, the bottom of the cloud serves as support when the price is falling through it. And the top of the cloud acts as resistance when the price is trying to rise out of it.
Base line (kijun sen)
The second part of Ichimoku Cloud is the “kijun sen” or “base line”. On most versions of this indicator, the base line is colored blue or white.
The base line is a 26 period moving average. When the price is above the cloud and moves below this line, it is a possible setup for a long trade. When the price is below the cloud and moves above this line, it is a possible setup for a short trade.
Conversion line (tenkan-sen)
The third part of Ichimoku Cloud is the “tenkan-sen” or “conversion line”. Usually, this line is colored red. It is a 9 period moving average.
If the conversion line falls below the base line while price is above the cloud, this is further confirmation that a buy signal may be coming soon. When the conversion line then rises above the base line, this is a buy signal.
The converse is true if the price is below the cloud. In this case, the conversion line rising above the base line is further evidence for a setup to short the stock. And when the conversion line recrosses below the base line again, this is the signal to actually enter a short trade.
Lagging line (chikou span)
The fourth and final part of the Ichimoku Cloud is the “chikou span” or “lagging line”. This is the simplest part of Ichimoku as it is just the current price pushed back 26 periods.
There are two ways to use the lagging line.
The first way is to use it as a confirmation of a conversion-line/base-line crossover. For example, let's say that the price is above the cloud and the conversion line has just moved above the base line. Instead of interpreting this right away as a buy signal, you can first check to see if the lagging line is above the cloud.
If it is, then you can go ahead and buy. But if it's not, you can wait for a later signal. This can help to keep you from getting whipsawed during times when the market is ranging.
The second way of using the lagging line is as an alternative buy/sell signal. In this case, enter a long trade when the lagging line rises above the price and a short trade when the lagging line falls below the price.
If you've been having difficulty figuring out which indicators to use in your trading strategies, you might want to dispense with them all and use Ichimoku Cloud instead. Use these strategies to make the Cloud work for you.