Interpreting the Chart

Here’s the complete chart that we looked at previously –

Interpreting the Chart

It’s actually of Abercrombie & Fitch, the ANF symbol. One of the most important aspects of the cloud chart is the interaction between the price and the clouds, specifically the cloud edges. Even though it might seem to be the price making its own target, as the clouds are moved forward in time, the price often interacts with the cloud edges, running along the edge or rebounding off it. Just look at how the price seems to change its path whenever it gets to the cloud edges. Sometimes it’s as little as a hesitation, a stutter, when it touches, and other times the cloud has a bigger effect.

For example, in the middle the price reaches the top of a red down-trend cloud, and immediately sets back down. On the right side,the price drops through a blue bullish cloud and then stops dropping when it reaches the lower red edge. Prices can react to the edges whether they approach them from the inside or the outside of the cloud.

In the same way as the previous charting methods, the cloud chart gives a direct way of telling if you are in an up-trend or a down-trend. If the price is above the cloud, it is bullish, and below the cloud it is bearish. Of course, the price can also be inside the cloud, and in that case you take your cue from how the price entered the cloud. If it drops in from above, which would normally be a bullish blue cloud, the trend is still bullish, and if the price comes in from below it is bearish. But as you would probably expect, prices inside the cloud can also indicate uncertainty and the possibility of a change.

The most significant cloud line for this is the Cloud Span B, the slower 52 period line which is coloured red. When the price crosses this, it can indicate a change of direction.

There are no specific rules about the meaning of the thickness of the cloud, but the cloud is thicker when the price is changing most rapidly. When the cloud gets thinner, it can indicate that a change of direction in the trend is coming.

Confirmation of a change in direction is usually given by the Lagging Line crossing the cloud. Almost inevitably, this happens after the price has crossed, because it is lagging, and it just shows that the movement is continuing, effectively confirming it. As the Lagging Line is only drawn later, when the price movement is apparent, this is a retrospective confirmation.

This may leave you looking for the price to cross the cloud to get a trading signal. This certainly can give a signal, but is more inclined to be early, and possibly a false signal. As with all trading, it’s a matter of interpretation, your trading style, and seeing what works best with your trading system.

Whether you choose the price or the lagging line crossing, you should find that both edges of the cloud are significant crossings. The edges of the cloud will tend to act as support and resistance levels. You should also look at candlestick signals when interpreting the cloud chart. They can provide confirmation of what the chart is telling you, and give you a timing signal for action.

Because the cloud lines are projected forward by 26 time intervals, it’s possible to see what to expect. In effect, it gives you thinking time before any events are revealed. While it cannot directly control what happens, there is a sense in which you need not be surprised by future outcomes. You can see where the price needs to be in order for a trend to continue, and this can help you with taking a view of the future.

One of the most obvious “at-a-glance” features of the cloud chart is the colour of the clouds, and the points where they change, the Cloud Span lines crossing. Once again, this is not necessarily used as a direct signal for trading, but it is another item of information that you can take into account.

As I mentioned, the Standard Line and the Turning Line are similar to moving averages, even while they are different in the method that they are generated. Therefore it is no surprise that you can use moving average techniques to interpret the movement of the lines. Using these lines, you get more frequent crosses and shorter term signals than the other signals discussed so far. Even with that said, there are two camps in Ichimoku devotees – one which considers these important, and another that prefers to use alternative signals and may even take these lines off to clarify the rest of the chart.

One method of using the Standard and Turning Lines is like the two moving average method. Remembering that the Turning Line is the shorter period line, being based on 9 days, when it crosses above the Standard Line this is a bullish signal. If an up-trend was in progress, some traders would buy on this signal, and sell their position when the line crossed back down. During a down-trend, they would sell short when the Turning Line crossed downwards over the Standard Line, and close the short position if it came back up.

This can work particularly well if the price is a long way from the cloud and there is a line crossing. If the lines are above the cloud in bullish territory and the Turning Line drops through the Standard Line, this may be early warning of a change to a down-trend, and vice-versa. While it’s sometimes thought risky to trade against the trend in anticipation of a reversal, you could simply use this signal as a reason to close a trend following bet before it moves against you.

Lastly, even if all this talk of the different types of lines leaves you cold, you can at least use the Ichimoku chart to give you immediate visual recognition of what type of trend you are in, for implementing a trend following strategy.

Although when they work, they can be very informative, you should note that Cloud Charts are not always effective. For a start, with all the time shifting that the drawing entails, they are really best when there are trends in place that provide something to work with. They really can’t add much to a trendless sideways chart where the actual crossings will be almost incidental. Sometimes you can get around this by considering a different time-scale where there will be a trend, but it depends if this fits in your trading style.

Another thought you may have is whether the standard periods that have been passed on to us are the best. There was a lot of painful hand calculation done when Ichimoku was first developed, and these were the numbers that came out best, but that was for the Japanese markets of 80 years ago. You can nearly always test different numbers with the aid of a computer, and find some that would have performed better, but that does not mean they will be better in the future. Some traders swear by the Fibonacci numbers of 8, 21 and 55, rather than the 9, 26 and 52 given here. If you look at it, this doesn’t really give much difference to the traditional numbers. Unless you really want to get detailed in your analysis, you are probably going to do very well using the standard periods.