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Technical Analysis - Kumo and Ichimoku

Forex traders buy or sell a currency pair depending on their analysis. If they are bullish, they’ll buy, if bearish, they’ll sell.

These opinions or educated guesses result from a technical or fundamental approach to the Forex market. One may buy the US dollar because he/she believes the Federal Reserve of the United States, the central bank, will raise rates. The other will simply buy the dollar because he/she believes the OTHER economy in a dollar pair will underperform over the next period.

Besides fundamental analysis, the technical analysis offers great opportunities to find profitable trades.  Technical analysis is the result of the Western world’s approach to trading.

Classical technical analysis patterns like the head and shoulders formation, the rising and falling wedges, channeling techniques, the pennants, the bullish and bearish flags…all come from the Western side of the world.

However, one of the most intriguing and interesting approaches come from Japan. Besides the Japanese candlestick techniques (that made the candlestick charts to become the most popular charts in the world), one indicator stands above them all: the Ichimoku Kinko Hyo.

Trading with Ichimoku

In rough translation, the Ichimoku indicator shows a stance of equilibrium. While it is offered as an oscillator on the MetaTrader platform, some other trading platforms look at it as a trend indicator.

I would dare to say it is both. The state of equilibrium comes from the fact that the indicator projects values both ahead of the current price, as well as back in time.

The standard default setting for the indicator is 26 periods. This means that the biggest part of the indicator, the most important one (the cloud or the kumo) is plotted 26 periods ahead.

In other words, if the indicator is set on the hourly chart, the cloud projects values 26 hours ahead of the current price. This is very important as traders use this for finding proper support and resistance levels.

Before looking at different strategies, let’s see the elements that make up the Ichimoku indicator:

  • The Tenkan line. This is the red line you see when you plot the indicator on the screen. It is some sort of a moving average, calculated a bit differently, and it is the first line that comes below (in a bullish trend) or above (in a bearish trend) the actual price. In a way, it acts like a fast-moving average, more like an EMA (Exponential Moving Average).
  • The Kinjun line. The blue line, Kinjun has more weight on prices. It acts as strong support and resistance levels for the actual price and some sort of a bigger moving average.
  • Senkou A and B. These two lines are the ones that define the cloud. When Senkou A crosses above Senkou B, the cloud turns bullish, or green. When the other way around, the cloud turns bearish.
  • The Chinkou. And then, there’s the Chinkou. Many struggle to find its importance, but this is a vital piece of information in the whole puzzle presented by the Ichimoku cloud.

In total, there are five elements that make the Ichimoku indicator, with the kumo taking the center stage.

Buying/Selling on Support/Resistance

The key with the kumo is to wait for the price to come and hit the cloud before buying or selling a currency pair. Because the cloud levels are known in advance twenty-six periods, the support and resistance levels are there too.

As a rule of thumb, the thicker the cloud, the stronger the support/resistance area is. On strong trends, one should look at the first time the price reaches the cloud.

If there is a chance for the price to react, the first time is that time. The more price comes to the cloud, the weaker the trend becomes and trading again should be avoided.

Therefore, look for a strong trend (ideally on the four-hour chart and above) that takes some time (a few days, a week, etc.) and wait for the first-time price hits the cloud. That is a nice entry level for a long trade (if the trend was bullish) or a short one (if the trend was bearish).

The currency pair makes no difference. What traders do is they use a risk: reward ratio based on the distance between the Senkou A and Senkou B, with the Senkou B acting as a stop loss.

As a reminder, a proper and realistic risk-reward ratio for the Forex market is anywhere between 1:2 or 1:2.5. This means that for every pip risked, the reward is two or two and a half pips.

technical analysis Kumo Ichimoku

However, conservative traders move the stop loss at break-even by the time the market moves on 1:1 ratio.

Trading Kinjun/Tenkan Crosses

Another way to trade with the Ichimoku indicator is to buy or sell when the Kinjun/Tenkan lines cross. In a way, it is like trading with the golden and death crosses in the classical moving averages approach.

In a bearish trend, if the indicator can have the Tenkan crossing above Kinjun, it shows the trend falters. Bulls are coming in and staying short is risky.

The same is valid in a bullish trend. These crosses define the entire environment and give a solid bias for the overall trend.

Trading the Senkou A/Senkou B Cross

Many traders use the cloud as a sign of future trends or as a change in the current trend. When the cloud color changes (from green to red) it means the Senkou A goes above Senkou B. This is a bullish sign for the 26 periods ahead. Staying short is risky.

On the other hand, when the cloud/kumo turns red, this is a bearish sign. It represents a warning sign ahead of a possible storm for bulls.

The beauty of this indicator is that you cannot miss the overall trend. Yes, sometimes, when the market is in a range, it can give conflictual signals.

To avoid that, stick with the higher time frames. Whatever you do, keep in mind that Ichimoku is NOT repainting, and the values posted on a chart are there to stay.

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CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74-89% of retail investor accounts lose money when trading CFDs. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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