- The Ichimoku Cloud indicator is a combination of many technical indicators.
- This indicator is used to identify the support and resistance levels, trend direction and the strength of the rally.
- Ichimoku Cloud comprises 5 lines, each having a particular formula and significance.
- The lines include 9-period average, 26-period average, the average of these two averages, 52-period average and a lagging closing price.
Formulae for Ichimoku Cloud:
- Conversion Line = (9-period high + 9-period low)/2
- Base Line = (26-period high + 26-period low)/2
- Leading Span A = (Conversion Line + Base Line)/2
- Leading Span B = (52-period high + 52-period low)/2
- Lagging Span = close plotted 26 period in the past
This is the 1 day chart of Nifty 50 index from Dec, 2019 to Aug, 2020
Conversion Line – Blue, Base Line – Dark Pink, Lagging Span – Violet, Leading Span A – Green and Leading Span B – Orange;
- The area between the lines -Leading Span A and Leading Span B- is shaded and it is called a cloud. If the price is below the cloud, the trend is downward and if the price is above the cloud, the trend is upward.
- The strength of the trend can be assessed based on the movement of the cloud. If the cloud moves in the same direction as the price, i.e., if the top of the cloud moves upwards during an upward trend, it signals a strong trend, otherwise, it is a weak trend.
- Similarly, if the bottom of the cloud moves downwards in a downward trend, it signals a strong trend, otherwise, it is a weak trend.
- If the price lies within the cloud, nothing can be inferred about the direction of the trend.
- If the Leading Span A is above the Leading Span B, it acts as a confirmation for an upward trend (green cloud in the chart).
- Similarly, if the Leading Span A is below Leading Span B, it acts as a confirmation for a downward trend (cloud is coloured red). Traders can use the cloud to identify the support and the resistance levels.
- If the conversion line moves higher than the base line and if the price is higher than the cloud, this indicates a strong buy signal.
- Traders can immediately initiate their long positions in the market. They can hold the trade as long as the conversion line lies above the base line. If it moves below, exit the trade and vice-versa for a sell signal.
- As we can see in the image, the main advantage of this indicator is that the cloud is extended into the future and traders can use this information to find the expected support and resistance levels before entering the trade. This additional feature is not found in other technical indicators.
- The main disadvantage of this indicator is the chart looks clumsy with many lines appearing as a cluster. So, many trading softwares added a new feature in which the trader can selectively hide the conversion line, base line and the lagging span line.