There are two vastly different ways to make money in the stock market. The first is to buy and hold stocks, looking to earn income through dividends and generate growth in capital as valuations grow over time.
The second is to execute short-term trades using technical analysis in an attempt to profit from the volatility, or uptrends and downtrends, seen in stock prices.
Successful short-term traders take advantage of several tools that generate trade signals from data found on price charts. Most tools and technical indicators in the trader’s toolbox offer small bits and pieces of the entire picture.
By combining these tools, price movement can be analyzed to find key support and resistance points, generating buy signals and sell signals.
The Ichimoku Cloud is a unique technical analysis tool, offering up a wide array of data at a glance. Using multiple moving averages and a base line, a cloud on a trading chart is formed, providing information with regard to volatility, trend direction, and potential for gains or losses ahead.
What Is the Ichimoku Cloud?
The Ichimoku Cloud was developed by Japanese journalist Goichi Hosoda, who published his work in the late 1960s. The Ichimoku Cloud combines a series of technical indicators to provide detailed trading information at a glance.
Most importantly, the technical indicator provides information surrounding:
- Support Levels. Support levels are the points at which stocks that are falling are likely to reverse directions and head for the top.
- Resistance Levels. Resistance levels are the points that stocks on an uptrend are likely to hit the top and begin to fall.
- Momentum. Momentum measures the velocity of price movements in the stock market. Stocks trading on high momentum are experiencing high levels of volatility and have the potential for generating large short-term returns. However, with high potential for gains often come high levels of risk.
- Trend Direction. The Ichimoku Cloud also helps the trader to clearly establish trend direction. This is an important technical indicator, as betting against a trend is a risky move.
To provide all of this information, the Ichimoku Cloud plots a series of moving averages on a stock chart, then adds a series of mathematical points, creating a cloud.
At first glance, this trading tool can seem convoluted and difficult to understand, but with a little practice, reading the Ichimoku Cloud can become second nature, and overwhelmingly valuable in your trading strategy.
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How to Set Up the Ichimoku Cloud
The Ichimoku Cloud uses a series of complex mathematical equations to generate the lines that compose the technical indicator. The good news is that you don’t have to be a mathematician to get your hands on the tool.
While few charting services offer the Ichimoku Cloud, Yahoo Finance makes it available to everyone for free. Simply search for the stock you’re interested in and click the “Full Screen” option in the top right corner of the stock chart.
Once the full-screen view loads, click “Indicators” in the top left of the chart and scroll down to find “Ichimoku Clouds.”
Once you click “Ichimoku Clouds,” the following screen will load:
The default settings from Yahoo Finance are the traditional settings used. However, these can be adjusted to better fit your unique trading strategy.
The settings determine the number of trading sessions in moving averages being plotted on the trading chart, which gives you the ability to fine-tune the tool to your trading time horizon, which we’ll review later.
How to Read the Ichimoku Cloud Indicator
Once you’ve entered your preferred settings and clicked the blue “Save” button, you will be brought to a screen that looks like this:
As you can see, the chart is now painted with a series of color-coded trend lines.
You’ll also notice that the space between two key trend lines is colored in, with some sections being green, and some being red. Each of these lines and shaded areas provide important information.
Although most people refer to the entire indicator as the Ichimoku Cloud, only one piece of the indicator is actually a “cloud.”
The Ichimoku Cloud is the shaded area found between the trend lines for leading span A and leading span B. The overall indicator, including the Ichimoku Cloud and all trend lines plotted on the chart. is known as the Ichimoku Kinko Hyo.
Although this may look too complex to understand, it’s actually quite simple using the following key:
The Conversion Line (Kenkan Sen)
The dark blue line on the chart above is the conversion line.
The conversion line is a plotted trend line that sits between the highs and lows over the past nine trading sessions by default. The number of trading sessions can be changed in the settings by changing the conversion line period.
The conversion line is a key level of support when prices trade above it, and resistance when prices trade below it.
If a stock that has traded below the conversion line breaks above it, it is known as a bullish breakout, and traders see the move as a buy signal.
Should a stock trading above the conversion line break below it, the move is considered a bearish breakout, and declines are expected ahead.
The Base Line (Kijun Sen)
The base line, or the red line on the chart above, trails the conversion line as the slower-moving average in the Ichimoku Cloud. It acts as the center point between the high and low prices of a stock over the past 26 trading sessions by default.
The base line, or trailing moving average, is often used as a trailing stop-loss when short-term traders ride an uptrend toward profits. Should prices fall to this point, positions are sold in fear of a bearish breakout.
Leading Span A (Senkou Span A)
Leading span A is another moving average, showing the trader activity over the past 52 trading sessions.
On the Yahoo Finance chart, leading span A will appear in a bright green color at the top of the shaded-in Ichimoku Cloud during bullish moves and at the bottom during bearish moves.
When leading span A rises above leading span B, an uptrend is confirmed. In this case, the shade between the two lines will be colored green, allowing traders to quickly identify the uptrend at a glance.
Conversely, when leading span A moves below leading span B, a downtrend is confirmed. In this case, the shade between the two lines is colored red, once again allowing for rapid identification of trend direction.
Leading Span B (Senkou Span B)
Leading Span B is the deep red trend line that forms the other edge of the shaded Ichimoku Cloud.
When leading span B is above leading span A, a downtrend is confirmed and the cloud is shaded red.
When leading span B is below leading span A, an uptrend is confirmed and the Ichimoku Cloud is shaded green.
Leading span A and leading span B act as key areas of support and resistance, and create a cloud to help determine the trend direction when looked at in conjunction.
Moreover, crossovers that take place above or below the Ichimoku Cloud can be powerful trading signals. When the conversion line crosses above the base line, and the price action takes place above the Ichimoku Cloud, it’s a strong bullish signal that significant gains are ahead.
On the other side of the coin, when the conversion line crosses below the base line and the price action takes place below the Ichimoku Cloud, the signal is a highly bullish one, suggesting that significant declines are likely ahead.
The Lagging Span (Chikou Span)
The lagging span can be found by looking for the brown line on the Yahoo Finance stock chart.
You’ll notice that the line is cut off 26 periods in the past by default, which can be adjusted by adjusting the lagging span period in the Ichimoku Cloud settings.
This trend line is used to help traders understand the relationship between current trends and previous trends in order to make wiser educated decisions. Many traders believe that when the lagging span crosses current prices, it’s a signal of a trend direction change.
Finally, the Ichimoku Cloud indicator can provide various sell signals. While riding an uptrend to profits, any of the trendlines on the chart are considered areas of support.
So, when a bearish crossover happens, meaning that the price of the stock falls below one of these many trendlines, it could be a sign of a reversal in direction and a signal to sell the stock.
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Ichimoku Cloud Configurations
The Ichimoku Cloud can be adjusted to meet the needs of the investor or trader that’s using it. The most common configurations are:
Traditional Ichimoku Cloud
The traditional Ichimoku Cloud is the original configuration and has been trusted for decades. It sets the key variables as follows:
- Conversion Line Period: 9
- Base Line Period: 26
- Leading Span B Period: 52
- Leading Span Period: 26
At the time the Ichimoku Cloud was developed, the average employee in Japan worked 46 hours per week in a six-day workweek. So, the default configuration for the Ichimoku Cloud is designed for a six-day workweek.
5-Day Workweek Ichimoku Cloud
The Ichimoku Cloud can be adjusted to be more accurate in terms of data during a five-day workweek using the following settings:
- Conversion Line Period: 8
- Base Line Period: 22
- Leading Span B Period: 44
- Leading Span Period: 22
This is one of the most popular configurations of the Ichimoku Cloud because the largest market in the world — the United States market — operates on a five-day workweek rather than the traditional Japanese six-day workweek.
Trending Markets Ichimoku Clouds
Traders tend to use the following Ichimoku Cloud settings when trading in trending markets with particularly high volatility:
- Conversion Line Period: 9
- Base Line Period: 30
- Leading Span B Period: 60
- Leading Span Period: 30
With the base line, leading span B period, and leading span period being higher values than the traditional configuration, the averages used in plotting the Ichimoku Cloud using this configuration represent more trading sessions, offering a higher level of stability in the data.
After all, long-term predictions have a much higher probability of coming true than short-term predictions.
- Conversion Line Period: 12
- Base Line Period: 24
- Leading Span B Period: 120
- Leading Span Period: 24
With this alternative, all the figures in the configuration have higher values than the traditional setup, ultimately representing far more data.
Although it will not be quite as sensitive to volatility in this configuration, this Ichimoku Cloud setup is another compelling option for those looking for long-term trends.
No Single Technical Indicator Is 100% Accurate
The Ichimoku Cloud indicator has quite a bit going for it. By combining multiple technical indicators into a single trading tool and taking several bits of data into account, it is one of the most accurate indicators out there today.
However, there’s no technical indicator or combination of technical indicators that’s right 100% of the time.
Trading is the act of attempting to predict future price movements in the market. Because nobody can see into the future, the action will lead to losses on some trades.
So, if you want to venture into the world of technical analysis-based trading, there are two guidelines that you should keep in mind:
- Don’t Place All-In Bets. Even the most successful short-term traders make losing trades. The stock market is volatile and highly unpredictable, especially when attempting to make predictions with regard to movement in the value of a stock over a short period of time. So, never make a trade with money you can’t afford to lose. A good way to make sure you don’t take on too much water is to limit the amount of money you risk on any single trade to 5% or less of your overall portfolio value.
- Use Multiple Technical Indicators. The Ichimoku Cloud indicator is a great tool, but it’s best to use other indicators to confirm your findings when you use this or any other technical analysis tool.
The bottom line is that any investment comes with risks. Those risks are exacerbated when predictions are made on a short-term basis.
It’s important to protect yourself from significant losses by limiting your exposure to any single short-term trade and taking advantage of multiple technical indicators that are at your disposal.
The Ichimoku Cloud is one of the most widely used technical analysis tools among successful day traders, and for good reason. There are few indicators that can provide information on momentum, trend direction, support, and resistance with a single glance.
If you plan on taking part in short-term trades, it’s a good idea to familiarize yourself with the Ichimoku Cloud and all of the information that it has to offer.
However, before you risk your first dollar, follow a few stocks that you believe will be good trades with the Ichimoku Cloud layered on the chart. This will give you a better understanding of what price action is likely to take place when the price nears or crosses key trend lines in the Ichimoku Kinko Hyo.
Once you get started, keep the risks in mind and protect yourself by using other technical indicators to verify your finding and limiting exposure should a trade prove to be a loss. Always do your research, always consider your risk, and always protect your investing capital.