When to Use the Ichimoku Indicator

[RichardCox 10]

One of the main reasons chart analysts use historical price behavior to gauge general momentum and market sentiment. The advantage of this type of analysis is that these patterns in sentiment and momentum can be assessed in real time, whereas fundamental analysis will often require traders to wait for market moving events and then make trading decisions directly afterwards. Trading tools like the Ichimoku indicator enable traders to to identify areas where conservative trade entries can be placed once the broader price direction is determined.

 

Not all indicators will work for all traders (either stylistically or even in terms of individual personalities). But it is important to try out a few different indicators in order to avoid getting pigeon-holed and miss the potential opportunities that might be found when other indicators are used. Different indicators will work better in different market environments so technical traders should at least test multiple options in order to determine what works best. The Ichimoku indicator is one of the lesser discussed indicators, so here we will look at some of the situations where the indicator should be used and where it should not be used to gain a better understanding of the situations where Ichimoku is most advantageous.

 

Maintain a Varied “Toolbox”

 

Your trading platform and charting software should really be viewed in the same way a toolbox would be used by a carpenter. You will rarely find a carpenter that has only one tool at his disposal. Additionally, it pays to remember the old phrase than when your only tool is a hammer, every problem starts to look like a nail. The financial markets are widely diverse and dynamic, and anyone with any experience trading these markets will tell you that no one tool or strategy will work in all situations. For example, trending markets will not exhibit the same patterns are markets that are range-bound, so it is essential to have a broader “toolbox” when actively establishing positions.

 

Avoid Ranges with Ichimoku

 

For the Ichimoku indicator, most of its applications are best suited for trending markets. Feel to take a look at the section’s previous article discussing this environment to get a better sense of the characteristics displayed when trends are in place. When the Ichimoku indicator is used in range-bound markets, you are more likely to get a sell signal near the bottom of the range (the buy zone), or a buy signal near the top of the range (a sell zone). Since there is a smaller chance for true agreement in the signals, the indicator is not compatible with these market scenarios. Of course, it is not possible to force a trend when one does not exist, so placing trades here with the wrong tools can leave to some highly frustrating results.

 

Watching for Trends

 

Given the “back and forth” signals that would be seen with Ichimoku during ranges, it starts to become clear that higher probability signals can be sent when higher highs and lows are visible (during an uptrend) or when lower highs and lows can be easily spotted (during a downtrend). When the 9 & 26 period Ichimoku averages are used for the trigger and base lines smaller market moves (during ranges) will not occur at price points that are advantageous for trades.

 

So, when looking for trends in conjunction with Ichimoku, the indicator reading itself can be extremely helpful. For example, prices breaking above or below the Ichimoku cloud can give excellent indications of where prices are likely to extend. In the charted example, we can see sell signals with prices falling below the cloud and extending a large distance before support levels are seen. In a bullish scenario the situation in this chart would be reversed. It should also be remembered that in cases where the cloud is not clearly above or below the levels seen in previous months, it is generally a better idea to stay away from trades and wait for better opportunities.

 

Trading Rules for Ichimoku Analysis

 

Now that we understand when Ichimoku analysis works and when it is not worth your time and effort, we need to establish some rules for how trades can be structured when using the indicator. Since the initial chart example present a sell trade, we will set the rules for buy positions. These rules can then be reversed when looking to establish sell positions. Before entering into buy positions, the following criteria should be seen:

 

• Price activity is holding above the Ichimoku cloud
  
• The trigger line is seen higher than the base line, os is starting to at least show a bullish cross
  
• More conservative traders will want to wait to make sure the lagging line is holding above the price activity seen 26 periods previously
  
• The Kumo is above the price action and is showing an upward trajectory
  
• Price levels for entries are not more than 300 points from the base line (because there is likely to be some volatility back to the line if extended moves are seen).
  

 

Once these conditions are met, high probability trading entries can be found when moving in the direction of the wider trend. As long as prices hold above the cloud and move below the base line, it is important to watch out for times when prices might cross back above the base line with increasing strength. Base line crossovers tend to be a good indication that the wider trend is resuming and this can be key for assessing how trades are likely to unfold. When looking to set stop losses, traders can use the technical support created by the cloud itself (in conjunction with pivot points or other support indicator) and then set stop losses below the cloud (for long positions). Profit targets can be determined using your risk to reward ratio and then based off of the risk exposure taken with the stop loss.

 

Conclusion: Consider Using the Ichimoku Indicator and Remember its Best Price Environments

 

The Ichimoku indicator can be a strong technical indicator to use when looking to expand on your trading “toolbox.” But it is important that (as with all indicators) there are certain situations where the indicator will best perform. For the Ichimoku, this tends to be in trending environments, rather than in range bound price activity. This helps to reduce the number of bad signals and use your trading time in more efficient ways. Certain criteria should be met for both buy and sell positions, and, in this respect, the Ichimoku has more rules than some of the other commonly used indicators. Luckily, the indicator is extremely visual in nature and once the different lines are understood, you will only need a quick glance at your chart in order to find new trading opportunities.