What is the Ichimoku Cloud?
The Ichimoku Cloud is a technical analysis method that uses sets of moving averages to produce key .levels in the past, present, and future. The cloud helps traders identify at a single glance if a security or other financial product is trading in bullish or bearish territory. Ichimoku Kinko Hyo literal- ly translates to ‘One Glance Equilibrium Chart’ because it can be used for analysis using only a glance. For this reason, the cloud is one of the most efficient technical indicators available. The cloud is made up of 6 key components, each of which we will examine individually later on. When these 6 components are combined they form the Ichimoku Cloud. Below is an image of the SPDR S&P 500 ETF Trust (SPY) on a daily chart with the cloud overlaid. We can use the cloud to identify key levels of support and resistance, determine trend, and determine the strength of the trend.
As can be seen in the image below the cloud is actually a forward-looking indicator. The cloud is projected 26 periods forward so the levels under the current price were formed 26 days ago (52 Days for my settings). The cloud is unique in this fact that is uses both past data and forward-looking levels. Since the levels are forward looking they tend to be more reliable than simple moving averages. The lagging indicator component also provides confirmation of breakouts by looking 26 periods ( (52 Periods for my settings) back to determine if a stock is likely to break through levels. It is this concept of looking at the past, present and future that makes the cloud so valuable.
What are the 6 Components of the Cloud?
The Ichimoku Cloud is made up of 6 individual components. Each is calculated and plotted differently and each one tells us something differ- ent. Here we will discuss how each component is calculated and what it is used for.
The 6 components:
1. The Tenken-Sen Line 2. The Kinjun-Sen Line 3. Senkou Span A
4. Senkou Span B
6. Chinkou Span Line
Once calculated, these pieces form the indicator set known as the Ichimoku Cloud. In the image of the SPY daily chart shown below, you can see the components clearly labeled.
Calculating the Individual Components
The Tenken-Sen Line: It is known as the turning line and is a signal of a region of minor support or resistance. This component is calculated by takingthe highest high and the lowest low divided by two over the past 9 periods (18 periods for me).
The Kinjun-Sen Line: Known as the confirmation line. This component also serves as a signal for support and resistance levels. Many traders use this line as a level for a trailing stop. It also serves as an indicator of trend. If price is above the Kinjun-Sen Line then the stock is in bullish territory, likewise if it is below the line it is in bearish territory. This line is calculated by taking the midpoint between the highest high and the lowest low over the past 26 periods (52 periods for me).
Senkou Span A: This line forms one of the boundaries of the ‘cloud.’ If the stock is trading above the line then the line will serve as a major support level. If price is below this line it will serve as a level of major resistance. This component is calculated by taking the average of the Tenkan-Sen and Kinjun-Sen lines. This line is unique in that the results of this calculation are plotted 26 periods ahead (52 periods for me). This means that today’s Senkou Span A line was actually plotted 26 days ago (52 days for me).
Senkou Span B: This line forms the other boundary of the ‘cloud.’ This line serves as a second level of support or resistance and is calculated by taking the midpoint between the highest high and the lowest low over the past 52 periods (104 periods for me). Like the Senkou Span A line, this is also plotted 26 periods ahead (52 periods for me).
Kumo: This is the shaded area, located between the Senkou Span A and Senkou Span B lines, that is used to form ‘the cloud’ itself.
Chinkou Span Line: This line is also known as the lagging indicator. This line is the current bar’s closing price plotted 26 periods back (52 periods for me). The lagging indicator is often used as confirmation of signals and can also serve as a support and resistance level. The lagging indicator can also assist a trader in confirming the direction and strength of trends.