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Trading With Ichimoku Clouds – Fast And Effective (Part 2)
Education | 09 February 2011
By: jason.liew
Articles (66) Profile

By Glenn Ho

The Moving Averages

Moving Average is arguably the most commonly watched indicator in the stock, currency and commodity markets. Price is expected to go bullish (bearish) when the faster moving average crosses above (below) the slower moving average. Calculation of moving averages is done by taking the mean of the past closing prices. A similar strategy is employed within the Ichimoku Kinko Hyo trading system with two lines; Tenkan Sen and Kijun Sen. We will now begin with the mathematics behind the Ichimoku Kinko Hyo components, starting with these 2 lines:

Tenkan Sen (“turning/conversion line”) = (HIGHEST HIGH + LOWEST LOW)/2 for the past 9 periods

Kijun Sen (“standard/base line”) = (HIGHEST HIGH + LOWEST LOW)/2 for the past 26 periods

These two lines signal trades like the standard moving average crossovers, but their calculation is quite different. Instead of utilising the mean of closing prices, they take the average of the highest high and lowest low of prices. This will allow us to determine the price equilibrium/ midpoint, which is also the 50% retracement if you draw a Fibonacci line between the highest high to the lowest low. Looking at price action relative to its equilibrium is the essence of the Ichimoku Kinko Hyo.

Picture of Price Action Relative to Price Equilibrium (Blue Line)

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Unlike the SMA, Tenkan Sen and Kijun Sen lines often have flat portions which represent equilibrium and quite naturally, we see prices retracing back to their equilibrium. Savvy Ichimoku Kinko Hyo practitioners often wait for retracements before taking trades. As the Kijun Sen measures price action over a longer historical period, it is a more reliable indicator of sentiment and equilibrium, reflected by the longer flat lines/equilibrium compared to the Tenkan Sen. This qualifies the Kijun Sen as a more significant level of support and resistance and traders tend to place their stop loss/exit orders near to these lines.

Picture Comparing Tenkan Sen and 9 Period SMA

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Except for one instance in the chart above, prices stayed above the Tenkan Sen in the areas highlighted in yellow, while prices dipped below the SMA numerous times. We thus see how Tenkan/Kijun Sen can be more accurate than the SMA. The angle of the Tenkan Sen also shows us the momentum of price action, with stronger momentum depicted by a steeper angle.

Trading Strategy: Tenkan Sen/ Kijun Sen Crossover

Traders can look to go long (short) when the Tenkan Sen crosses above (below) the Kijun Sen. Unlike traditional SMA strategies, the strength of the Tenkan Sen/ Kijun Sen Cross can be ascertained based on its position relative to the cloud as follows:

  • A strong tenkan sen/kijun sen cross Buy (Sell) signal takes place when a bullish cross happens above (below) the kumo.

  • A neutral tenkan sen/kijun sen cross Buy/ Sell signal takes place when a bullish cross happens within the kumo.

  • A weak tenkan sen/kijun sen cross Buy (Sell) signal takes place when a bullish cross happens below (above) the kumo.

Traders can exercise risk allocation and position sizing based on the strength of the crossover. The more conservative Ichimoku Kinko Hyo practitioners ignore weak crosses altogether.

Picture of Tenkan Sen/ Kijun Sen Cross Strategy

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This article’s author, Glenn Ho, is Director at APF Trading, a trading advisory firm offering clients Managed Forex Accounts and advice on multi-asset trading strategies, signals, trading systems, execution services and trading platforms. The firm also conducts research and technical analysis with a focus on Ichimoku Kinko Hyo and DeMark Indicators. Glenn previously worked at Jefferies & Company, a New York – based Investment Bank, as well as UBS Investment Bank and Citigroup Private Bank. He contributes regularly to AsiaPacFinance.com.


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