While it’s referred to as an indicator in its own right, the Ichimoku Cloud is actually a combination of indicators based on five formulas that combine to form an equilibrium chart.
These five formulas provide a data-rich indicator that displays lines of support and resistance, trend direction, and momentum of that trend through the charting of several different moving averages on the same chart. Here’s a quick guide to understanding the Ichimoku Cloud and tips to get started using this indicator as part of your trading process.
How do you read the Ichimoku Cloud indicator?
The unique feature of this indicator is the cloud formations that represent the space between leading spans A and B displayed on the chart. Leading span A represents the moving average of the conversion line and the baseline while leading span B represents the average of the 52-week high and the 52-week low.
This space between these lines is colored green when span A is above span B, which signals an uptrend in price. By contrast, the cloud is colored red when span B is above span A, suggesting a downtrend. In the EUR/JPY chart below, you can see both green and red clouds represented alongside other lines used to evaluate the currency pair.
Although this chart may seem complex to the untrained eye, it actually offers straightforward insights into a currency pair’s performance. For that reason, it has gained popularity among forex traders in recent years, including among novice traders experimenting with indicators as they develop their trading strategy.
What are the advantages and disadvantages of this indicator?
Like any indicator, the Ichimoku Cloud offers strengths and potential disadvantages, depending on how you use the chart to inform your trading strategy.
The top benefits of using the Ichimoku Cloud include:
You can review extensive performance data available at a glance.
Few indicators offer a quick view of lines of resistance and support while displaying momentum and trends all within a single calculation. This makes the Ichimoku Cloud both convenient to use and synergistic as a chart evaluation tool since all of the lines and data on the chart are displayed in correlation with one another.
You have the ability to confirm trends within a single indicator.
With most other indicators, you’ll get one indication of a trend or signal, and then use another indicator to see if that analysis confirms the initial signal. Although most traders don’t use Ichimoku Cloud as a standalone indicator to evaluate charts, the option is available through this indicator—and some proponents of Ichimoku Cloud may occasionally use this without other indicators to provide a confirmation.
It pairs well with RSI.
To provide even more confirmation and scrutiny of Ichimoku’s indicators, the relative strength index (RSI) provides a separate and complementary approach to analysis.
It can be customized in most trading platforms.
While the Ichimoku Cloud can appear busy on the screen, platforms such as MetaTrader 4 or 5 allow you to easily remove certain lines that you aren’t using at any given time, providing a clearer view of the data and lines that matter most.
Despite these advantages, Ichimoku Cloud isn’t without certain limitations, particularly depending on how you like to approach trade analysis, and how you try to enter and exit trades. These limitations include:
Trade indications are based on lagging data.
Traders who seek a more predictive approach may be frustrated with the lagging signals provided by the Ichimoku Cloud. Because it’s based on moving average data, this limitation is unavoidable—and may be a significant turnoff for some traders.
Wealth of data and chart lines aren’t always beneficial.
While it’s great to feature a lot of information on a single chart, a busy chart can actually disrupt your ability to evaluate trades. This can be remedied by customizing the indicator and removing lines you don’t want, but it creates extra steps that can slow down your analysis.
Trends may lose their relevance for traders focused on longer trading time frames.
The moving averages can be great for day and intraday trading, but the time frames for the moving averages used in the Ichimoku Cloud don’t serve traders focus on long-term positions that may be held for months at a time. Longer moving averages and/or other technical indicators may be turned to as a supplement to, or in the place of, the Ichimoku Cloud.
What are some best uses of the Ichimoku Cloud indicator?
Whether you plan on using the Ichimoku Cloud as a core indicator in your trade analysis, or as an occasional tool outside of your preferred indicators and analysis tools, consider the following best practices to get the best value from this calculation:
- Open positions when the cloud color changes to green, indicating a breakout. In many cases, this initial crossover will lead to a sustained period of upward trend, which you can monitor through momentum and trend indicators.
- Consider closing your position when the cloud crosses the 26-day moving average—typically a blue line on your chart.
- Exit your position when the currency pair’s price moves below the conversion lines and baselines. These two crossovers confirm a bearish signal.
- As with any other trade based on indicator signals, use a stop-loss to limit your losses.
Why should you add another tool to your trading tool kit?
No matter how frequently or rarely you use Ichimoku Cloud, it’s helpful to understand how this indicator works if you find yourself in need of its analysis in the future. The more you understand the different theories and principles developed over the decades by savvy forex traders, the more equipped your own strategy will be to maximize profits and minimize risk.
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The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.