Trading with Ichimoku kinko hyo (I)

How to use and What makes up Ichimoku

The Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a versatile indicator that defines support and resistance, identifies trend direction, gauges momentum and provides trading signals. Ichimoku Kinko Hyo translates into "one look equilibrium chart". With one look, chartists can identify the trend and look for potential signals within that trend. The indicator was developed by Goichi Hosoda, a journalist, and published in his 1969 book. Even though the Ichimoku Cloud may seem complicated when viewed on the price chart, it is really a straight forward indicator that is very usable. It was, after all, created by a journalist, not a rocket scientist! Moreover, the concepts are easy to understand and the signals are well-defined.

What makes up Ichimoku ?
Ichimoku is make up of 5 indicators.

1. Tenkan sen
2. Kijun sen
3. Chikou span
4. Senkou Span A
5. Senkou Span B

Tenkan sen (‘turning line’) or the short ‘moving average’
Unlike typical simple moving average, where the day’s closing price is taken and calculated, Tenkan sen is calculated as (HIGHEST HIGH + LOWEST LOW)/2 for the past 9 periods or 7 periods.
The angle of the Tenkan sen can be used to suggest the strength of the momentum. If it is a steep line, we can say that the underlying has a change in momentum and is very strong. Look at Palm’s chart below. See how Tenkan sen change when Palm Pre is announced.

Kijun sen (standard line’) or the higher timeframe ‘moving average’
Kijun sen is calculated using (HIGHEST HIGH + LOWEST LOW)/2 for the past 26 periods or 22 periods.
This is the longer timeframe line and is less sensitive to current price changes. However, it is a key indicator for major change in trends.

Chikou Span (the “lagging line”)
This is shown on the chart as a lagging line behind the price. In the chart below, it is the green line and it is calculated as CURRENT CLOSING PRICE time-shifted backwards (into the past) 26 periods or 44 periods.

Chikou Span is one of the unique feature of Ichimoku. And this is the line that I used to determine the support and resistant levels. Why is Chikou Span shifted 26 periods back? The answer becomes clear once you understand that a change in trend is a relative state. For example, if the trend is up and it continues to goes up, then there is not change in trend. By shifting it bacwards 26 period, we can compare the current price level to how it looks like 26 periods ago. With a glance of the position of the current price level and Chikou Span, we can quickly identify if the trend is changing and is it going to break through any possible support or resistant levels.