by Jamie Holmes
If you want to invest in or trade cryptocurrency, a powerful predictive tool that is often overlooked is the Ichimoku Kinko Hyo. The Ichimoku Kinko Hyo method originates from Japan and has been under-utilized by professionals in the West due to the lack of translation and guidance on how to actually use it, with most dismissing it as an exotic indicator.
It is only in the past decade or so that Westerners have started to understand the power of Ichimoku Kinko Hyo.
This indicator works very well for BTC-USD and other cryptocurrencies, as well as working successfully for Asian traders trading in stocks, commodities, and futures. Ichimoku Kinko Hyo translates into English as ‘equilibrium chart at a glance.‘
You can take a quick glance at the chart and immediately find the balance point, or ‘equilibrium zone’ for the asset in question. Invented by Goichi Hosoda, a journalist, he released the Ichimoku system to the public in 1968 after he recruited a group of students to run simulations by hand to test the system for two decades.
The Ichimoku system allows you to identify breakouts and jump on an ongoing trend. Moreover, it can give signals to enter trades and allows you to gauge momentum.
While the indicator is made up of four components, they all must be assessed relative to the market price to understand what is going on in the market. Use the components jointly to form an integrated whole picture of price action that can be realized by just a glance.
At first, using this indicator can be daunting but after a while, it becomes very easy to use. You will then have an almost instant understanding of the strength of the current trend and momentum.
When using the Ichimoku Kinko Hyo, think in terms of equilibrium and disequilibrium. Since the market is a composite of all individual, human traders, the market is a reflection of group behavior. Just as you cannot stay happy or angry forever, we must return to the mean, so does the market.
This brings us to the Ichimoku cloud or ‘Kumo’.
1. The Ichimoku Cloud or the ‘Kumo’
The first component that will be detailed is the Ichimoku cloud (or ‘Kumo‘) which represents the equilibrium zone over time. If the price is inside the Kumo then we can say the market is in equilibrium;
Equilibrium… the state of a system where there are two equal, opposing forces such that the system is stationary. Therefore, when the price is within the Kumo we should look for a breakout of this equilibrium as this will give an early entry into the most likely future direction.
Examination of the Kumo will also allow you to realize two things; the overall trend and the price’s relationship to that trend. Moreover, it provides a multi-dimensional view of support and resistance. This is an improvement over the simplified, linear view of traditional support and resistance at a certain level. Instead, in reality, the dynamics of the market causes to support or resistance zones to expand and contract.
If the price is within the Kumo, the market is trendless. If the price is above the Kumo, then we have an uptrend whereas if the price is below the Kumo we have a downward trend. For example, the chart below shows the 4-hour price action for BTC-USD along with the Ichimoku cloud/Kumo. In this instance, we see that BTC-USD breaks above the Ichimoku cloud during July 12, 2016, which is also known as a ‘Kumo breakout’.
This gives a bullish signal and we could have entered into a buy position once there was a 4-hour close above the Kumo. However, a smarter strategy is to wait for the market to test the support zone provided by the Kumo. Generally, if the price is above the Kumo, then the Kumo will provide a zone of support. On the other hand, if the price is below the Kumo, then it will be a resistance zone.
After breaking above the Kumo, the chart below shows that the market pushed down into the Ichimoku cloud. However, this is the time to buy as the relationship between the price and Kumo is signaling an uptrend and the Kumo currently providing support. Buy positions would then be suggested. Following the push into the cloud, the market found support inside this zone and continued upwards from ~$650 to a high near $685.
Buy signal – Kumo breakout
Sell signal – Kumo breakout
Below you can see the same thing but for a breakout to the downside.
So we have looked at the signals the Kumo gives for identifying the start of a trend but it also gives a multi-dimensional view of support and resistance, as mentioned earlier. For example, consider the chart below. This was BTC-USD back in May 2016.
As you can see below, the depth of the Ichimoku cloud varies widely over the course of around two weeks. The depth is an indication of market volatility and hence the extent of support or resistance that will be found in this zone.
The thicker the Kumo, the greater support or resistance it will provide. The thinner the Kumo, the weaker the support or resistance will be; this is illustrated below where a thin Ichimoku cloud was easily broken by the market. Therefore, we are more likely to see the price change its relationship with the Kumo when the Kumo is relatively thin.
Moreover, clues about the current and future trends are provided by the change in the color of the Ichimoku cloud. For example, in the chart above when the Kumo turned from green to red, this was warning us of the impending downward move that bought BTC-USD as low as $435.
Therefore, when the Kumo starts to change color we should be ready to take a position. Also, if we spot a thin section of the Ichimoku cloud which sticks out, we should anticipate a break of the support or resistance provided by the cloud. For instance, a potent example of how you can use the thin cloud is shown below.
Get ready to take long position early on August 17, as we expect weak resistance from the cloud.
2. Tenkan Sen or ‘Base’ line
The Tenkan Sen is the average of the highest high and lowest low over the previous 9 periods and consequently better captures the market’s equilibrium and points of support/resistance than a simple moving average.
When the Tenkan Sen is flat, it indicates a trendless condition in the market over the past 9 periods. When it is not flat, the angle indicates the relative momentum of the price action over the previous 9 periods. If the price is above the Tenkan Sen it will act as support. Conversely, the Tenkan Sen provides resistance when the price trades below it. But given the short-term nature of this component, it is not as reliable as the other signals in the system. Nevertheless, the price crossing over the Tenkan Sen is usually a good indicator of a shift in momentum.
For example, if the price action breaks above the Tenkan Sen this signals a shift to upward momentum. Whereas if the price moves from above to below the ‘base’ line this indicates a higher likelihood of downward momentum over the short-term. However, as with all Ichimoku signals, this should be evaluated against the other three components.
3. Kijun Sen or ‘Conversion’ line
The third component is the Kijun Sen or ‘conversion’ line which is the highest high and lowest low averaged over the previous 26 periods. The Kijun Sen essentially works in the same way as the Tenkan Sen but since it covers a longer time period, it is more accurate at determining momentum and support/resistance. Two main signals are given by the conversion line.
This is illustrated in the chart below which shows that the conversion (blue) line gives a tighter level of support and resistance and a more accurate depiction of price equilibrium. Also, notice that when the conversion line is flat, the price action is attracted to it and we experience the ‘rubber band’ effect. The price rotates around this equilibrium level swinging away then back towards the Kijun Sen. Therefore, we can buy/sell if the price is significantly lower/higher than a flat conversion line.
Another signal is the crossover between the Tenkan Sen and Kijun Sen. The chart below displays how to use this strategy.
4. Chikou Span or ‘Lagging’ line
The Chikou span or ‘lagging’ line is the current price time-shifted back 26 periods. The main signal given is trend confirmation. Once the Chikou span moves from above to below/below to above the Ichimoku cloud, this provides a signal. For example, consider the chart below. The arrow highlights that the lagging line is moving above the Kumo, providing a buy signal. This confirms the bullish Kumo breakout and strongly confirms an upward trend is underway.
Therefore, we use the lagging line to find a support level, indicated on the chart with the yellow ray. We buy BTC-USD when the price touches this level, which it does after 12 hours or so. After testing this support, we see that the upward trend continues. To exit this trade, we would also use the lagging line to determine a resistance area where the upward trend may exhaust itself.
To do this, we zoom back and find the most recent peaks (or troughs in case of a downtrend) and set our take profit levels accordingly. This is illustrated below.
The Chikou span is unconventional in that it time-shifts the current price to compare with the historical price action. If the Chikou span is above the previous price action, then this is bullish. Whereas if the Chikou span is below the previous price action then this points to more bearish action to come.
An Integrated Picture
Use all of the components together to form an integrated picture. The chart below shows a crossover of the Tenkan Sen and Kijun Sen which provides a risky but highly profitable buy for BTC-USD.
This is further confirmed by the Chikou span when it moves above the Ichimoku cloud.
Also, at this point, the Chikou span is also above the previous price. Therefore, the integrated picture points to an upward trend, so we should wait for the market to find support before buying.
Longer time frames are better, providing more reliable signals such as the monthly, weekly, daily and 4-hour. Shorter timeframes generate too much noise and provide less reliability and more opportunities for fake signals. You may also want to do mutli-timeframe analysis, which will help you get to grips with the Ichimoku technique. For instance, we can watch the 4-hour chart, take actions on the 15 minute or 5 minute chart; if the 40hour chart leans bullish, we can look for buy signals on the lower timeframes and take these entries.
The Ichimoku method is based on probabilities, and back-testing can give you a better indication of the risk you are taking when acting on various signals. I personally like to wait for confirmation and execute lower risk, lower reward trades. Monthly and weekly closes provide information on longer trading sessions and these Ichimoku signals are invaluable. For instance, consider below the simple weak buy signal given by XEM-BTC, which was a hugely profitable trade for the first half of 2017. The weekly close was higher than the conversion line, a weak buy signal.
Below we see that the Ichimoku signal was proved to be reliable, with a long-term drift toward the cloud, as the signal would suggest (a close above the conversion line generally points to a return to equilbrium, i.e., the Kumo).
Also, you can combine this indicator with volume to generate a richer outlook. One disadvantage is that the Ichimoku system can be hard to get your head around at first and takes some practice. Also, a further disadvantage is that it does not explicitly state where to put a stop loss so you have to also find out how much risk you are willing to take and whether or not that risk is justified.
This guide was updated October 23, 2017, and will be updated with further examples/explanations in the near future.