Ichimoku Kinko Hyo is one of the most overlooked and misunderstood indicators in the western world. Many people believe that is too complex and therefore turn to traditional oscillators and indicators like RSI, CCI etc. At first it looks intimidating due to the number of lines on the chart, but if anyone dedicates some time to study it, he will find that it is actually quite simple and that it can be an almost perfect tool for trading in any time-frame. These series of articles will try to make traders familiar with Ichimoku and hopefully help them to be successful in one the most exciting, but difficult professions in the world.
What is Ichimoku Kinko Hyo?
Ichimoku was created by Goichi Hosoda in Japan almost a century ago. It is a trend and breakout indicator that besides identifying when to open a position, it also shows support and resistance levels. This is how it looks when plotted on a chart,
(if the images do not show right please use the zoom option of your browser)
It looks complex and later in the series there will be a full explanation of the indicator together with trend and breakout strategies. This part focuses on breakout, intraday trading using just the Cloud (Senkou Span A&B) and the Lagging Line (Chinkou Span). This is how our chart now looks like,
There is no need to understand the mathematics of the indicator (easily available online). A trader only needs to know that the cloud is showing support & resistance and the lagging line momentum. This is Ichimoku in its purest form.
A Kumo Breakout occurs when price closes above the top, or below the bottom of the cloud. For intraday trading a trader should use a 15 minute chart. The image shows an upside break,
It is obvious that it is a failed break. The pair reversed immediately and the trade would have resulted to a loss. This is where the lagging line (blue line) can help us avoid failed breaks. All breakouts need momentum and the lagging line is our momentum indicator. Here is the same break,
The highlighted area shows that at the time of the break the lagging line was below the top of the cloud and although price went up, the lagging line could not break cloud resistance and shortly after the pair reversed sharply.
The next image shows a successful breakout,
Price broke the bottom of the cloud at point A. At that time the lagging line was inside the cloud, but did not broke the bottom. Therefore there is no trade. But after the close of the next 15 minute candle, the lagging line broke through at point B and a trader now has confirmation and opens the trade at point C. Now there is a high probability Kumo Breakout and the trader can manage his position.
Setting stops and limits.
Risk management is the most important aspect of trading and Ichimoku can offer very aggressive risk reward ratios. Setting the stop is simple. The trader should exit the trade only when an opposite successful breakout occurs. As for limits a trader has many options. Pivot points, ATR, Moving Averages, Fibonacci just to name a few. In any case a trader should always use a minimum risk reward ratio of 1,5:1. And at this point Ichimoku shows its full beauty. When a trade results to a loss, it will be very fast and almost always small. Therefore there are not large losses and lengthy drawdown. And a small stop-loss can offer an aggressive risk reward trade. A high probability trade can have a R:R ratio up to 3:1.
Stops & limits: Cloud and Daily Pivot Points (dashed lines).
All successful traders strongly recommend to keep things simple and the charts as clean as possible. Do not use too many indicators and always let your emotions aside. Just follow the rules of the strategy and the Ichimoku Breakout strategy has few and simple ones that if followed, they will not betray you. As you can see in the chart there are no oscillators, trend lines, moving averages or any other indicator. Just Ichimoku, pivot points and the most important aspect of all, Price Action. The example will show two options that a trader had for this particular trade. The first is conservative, and this is how I managed the position and the second is the aggressive way that shows the full power of Ichimoku.
I sold 2 lots at 1.6667 (C). My stop-loss was 40 pips higher (D) and the limit for the first lot was set at 60 pips (E) just above the S1 pivot. I had a 1.5:1 R:R ratio. A few candles later price hit my limit (E) and I closed the first lot. At that time I moved the stop-loss for the remaining lot to break-even and therefore I had a risk free trade that I can let open for the next day. On day 2 I set my limit at the S1 pivot and price reached it easily (F). I had a profit of 60 pips for the first lot and 111 for the second. Now as you can see price kept falling throughout the day and I could have a greater profit. It did not matter for me since I followed my rules and as soon I close a trade, I forget it.
The aggressive option would be to let the second lot open until an opposite Kumo break and at the same time, when price broke through S1 at day 2 to move the stop-loss a few pips above that level. By doing that a trader had secured another 50 pips and can let the breakout run its course. At day 3 a Kumo break occurred and the lot is closed with a profit or 150 pips.
I use both options in my trading depending on the volatility and market conditions. Later in the series, there will be a presentation on when to be aggressive or conservative by analyzing Ichimoku components and also Swing and Trend trading strategies. The above short-term strategy is simple and offers low-risk opportunities. It is the first step in understanding Ichimoku and if a trader becomes familiar with it then it can use the more complex components of the indicator and enjoy the full power of Ichimoku Kinko Hyo.