How to Use Ichimoku Charts in Forex Trading

What Is the Ichimoku Chart?

The Ichimoku Kinko Hyo chart is a technical analysis tool that isolates higher probability trades in the forex market. Also called the equilibrium chart, it has gained popularity among novice and experienced traders.

Known for its applications for futures and equities, the Ichimoku includes more data points than other charts. This provides a more reliable price action.

The application offers multiple tests and combines three indicators in one chart. This helps a trader make better-informed decisions about investing.

Learn how the Ichimoku works and how it can be applied to a trading strategy.

Understanding the Ichimoku Chart

A trader needs a basic understanding of the components of the Ichimoku chart before they can use it effectively.

The Ichimoku was created in 1968 in a manner unlike most other technical indicators and chart applications. While applications were usually formulated by statisticians or mathematicians in the industry, the Ichimoku was constructed by a Tokyo newspaper writer named Goichi Hosoda and a handful of assistants running multiple calculations.

This indicator is now used by many Japanese trading floors because it offers multiple tests of price action, creating higher probability trades. Although many traders are intimidated by the abundance of lines drawn when the chart is actually applied, the components can be easily translated into more commonly accepted indicators.

The application is made up of four major components and offers the trader key insights into forex (FX) market price action.

Components of the the Ichimoku Chart

Tenkan Sen and Kijun Sen Lines

First, we'll take a look at the Tenkan Sen and Kijun Sen lines. The lines are used as a moving average crossover and can be applied as simple translations of the 20- and 50-day moving averages, although with slightly different timeframes.

• The Tenkan Sen: Calculated as the sum of the highest high and the lowest low divided by two. The Tenkan is calculated over the previous nine time periods.
• The Kijun Sen: Calculated as the sum of the highest high and the lowest low divided by two. Although the calculation is similar, the Kijun takes the past 26 time periods into account.

The trader will want to use the crossover to initiate a position, similar to the way a moving average crossover is used. Looking at our example in Figure 1, we see a clear crossover of the Tenkan Sen (yellow line) and the Kijun Sen (orange line).

This indicates that near-term prices are dipping below the longer-term price trend, signaling a downtrend or a move lower.

The Ichimoku Cloud

Now let's take a look at the most important component, the Ichimoku Kumo or cloud, which represents current and historical price action. It behaves in much the same way as simple support and resistance levels by creating formative barriers.

The cloud is created by Senkou Span A and Senkou Span B:

• Senkou Span A: The sum of the Tenkan Sen and the Kijun Sen divided by two. The calculation is then plotted 26 time periods ahead of the current price action.
• Senkou Span B: The sum of the highest high and the lowest low divided by two. This calculation is taken over the past 52 time periods and is plotted 26 periods ahead.

Once plotted on the chart, the area between the two lines is the cloud. Comparatively thicker than typical support and resistance lines, the cloud offers the trader a thorough filter.

The thicker cloud tends to take the volatility of the currency markets into account instead of giving the trader a visually thin price level for support and resistance. A break through the cloud and a subsequent move above or below it will suggest a better and more probable trade.

Let's take a look our US dollar/Canadian dollar (USD/CAD) example. We see a comparable difference between the two currencies. Although we see clear support at 1.1522 in our standard chart (Figure 2), we subsequently see a retest of that level.

At that point, some trades probably will be stopped out, which is somewhat concerning for even the most advanced trader.

But in our Ichimoku example (Figure 3), the cloud serves as an excellent filter. The cloud suggests a better trade opportunity at a break through 1.1450 by taking the volatility and apparent take back into account. Here, the price action does not move back, and the trade can ride the overall downtrend momentum.

The Chikou Span

The last piece of the Ichimoku is the Chikou Span. Seen as simply market sentiment, the Chikou is calculated using the most recent closing price and is plotted 26 periods behind the price action.

This feature suggests the market's sentiment by showing the prevailing trend as it relates to current price momentum. The interpretation is simple: As sellers dominate the market, the Chikou span will hover below the price trend.

The opposite occurs on the buy-side. When a forex pair remains attractive in the market or is bought up, the span will rise and hover above the price action.

Trading the Ichimoku Cloud

There's no better way to learn how to trade the Ichimoku chart than by applying it to an example. Let's break down the best method of trading the Ichimoku cloud.

Taking our U.S. dollar/Japanese yen (USD/JPY), the scenario in Figure 5 will focus on the currency pair fluctuating in a range between 116 and 119. Here, the cloud is a product of the range-bound trading scenario over several months and stands as a significant support and resistance barrier. With that established, we look to the Tenkan Sen and Kijun Sen.

As mentioned above, these two indicators act as a moving average crossover, with the Tenkan representing a short-term moving average and the Kijun acting as the baseline.

In our chart above, the Tenkan dips below the Kijun, signaling a decline in price action. However, with the crossover occurring within the cloud in Figure 5, the signal remains uncertain and will need to be clear of the cloud before an entry can be considered.

We can also confirm the bearish sentiment through the Chikou Span, which at this point remains below the price action. If the Chikou were above the price action, it would confirm bullish sentiment. Putting it all together, we are now looking for a short position in our USD/JPY currency pair.

When To Enter

We will want to see a close of the session below the cloud before initiating any type of short sell position because we are equating the cloud to a support/resistance barrier.

Here, we have a confirmed break of the cloud as the price action stalls on a support level at 114.56. The trader can now either opt to place the entry at the support figure of 114.56 or place the order one point below the low of the session. Placing the order one point below would act as confirmation that the momentum is still in place for another move lower.

Subsequently, we place the stop just above the high of the candle within the cloud formation. In this example, it would be at 116.65. The price action should not trade above this price if the momentum remains. Therefore, we have an entry at 114.22 and a corresponding stop at 116.65, leaving our risk out at 243 pips.

Protecting Against Risk

In keeping with sound money management, the trade will require a minimum of a 1:1 risk/reward ratio with a preferable 2:1 risk/reward for legitimate opportunities. In our example, we will maintain a 2:1 risk/reward ratio as the price moves lower to hit a low of 108.96 before pulling back. This equates to roughly 500 pips and a 2:1 risk to reward—a profitable opportunity.

Bear in mind that the Ichimoku is applied to longer timeframes, and this instance shows daily figures. The chart will not work as well with many technical indicators since the volatility is in shorter timeframes.

Summary: How To Use the Ichimoku Chart

1. Refer to the Kijun/Tenkan crossover. The potential crossover in both lines will act in a similar fashion to the moving average crossover. This technical occurrence is great for isolating moves in the price action.
2. Confirm the downtrend/uptrend with Chikou. The probability of the trade will increase with confirmation that the market sentiment is in line with the crossover, as it acts in a similar fashion with a momentum oscillator. Oscillators are technical indicators that track price action with upper and lower bands.
3. Price action should break through the cloud. The impending trend should make a clear move past resistance or support. This action will increase the probability of the trade working in the trader's favor.
4. Follow sound risk management when placing entry trades. The trader will be able to balance risk/reward ratios and control the position by adhering to strict money management rules.

The Bottom Line

The Ichimoku chart can be intimidating at first. But once understood, traders should find it helpful.

The chart combines three indicators and offers a filtered approach to the price action for the currency trader. It not only can increase the probability of a potential trade in the FX markets but can help isolate true momentum plays.

The Ichimoku provides an alternative to riskier trades, where the position has a chance of stopping out and giving back profits. The comments, opinions, and analyses expressed on

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