At first glance, the Ichimoku indicator is a trading tool that looks very fancy and many traders are intimidated by all the different lines and shapes that the indicator produces on their charts. We are here to show you that once you understand how to read the Ichimoku indicator, you will quickly see that the information and the signals this trading indicator provides can be very helpful and easy to implement in your own trading.
The three signals of the Ichimoku indicator
The Ichimoku indicator provides three different types of information about price action and market sentiment. First, it shows the direction of the trend; second, it visualizes momentum and trend strength; and it also acts as support and resistance.
Before we get started, let us show you how to change the look of the Ichimoku indicator in Metatrader so that it is easier to interpret and use. The left chart shows the standard look of the Ichimoku indicator in Metatrader and the right one the new, adjusted look. The information on the right are much easier to understand.
You can get the adjusted look of the Ichimoku indicator with a few clicks. First, open the settings of the indicator and go to colors. Then, just copy the settings from the screenshot below. We deactivated the “Chikou Span” since it is not needed for our purposes (red shaded box). To make the Ichimoku cloud easier to see, we have changed the setting for it as you can see in the blue shaded box.
Getting to know the Ichimoku indicator
Although the Ichimoku indicator can look intimidating at first glance, it is easy to use once we understand the basic principles behind it. Before we get into trade examples, we have to understand what the different lines are.
The red line (Conversion line) is the fastest moving line. It shows the middle of the previous 9 candle period. That means it’s the middle of the range of the past 9 candles. The blue line (Base line) moves slightly slower. The blue line marks the middle of the range of the past 26 candles. Essentially, the red and blue lines are similar to moving averages.
The cloud consists of two lines. As you can see, one moves faster and one cloud boundary adjusts slower. The faster moving line is the middle of the red and blue lines from above. The cloud boundary that moves stepwise is the middle of the 52 candle period.
As you can see, all lines represent some form of price averages. Using price averages allows the trader who uses the Ichimoku indicator to immediately see momentum, trend direction and support and resistance. We will now explore how to identify trading opportunities using the Ichimoku indicator.
Trend direction
The Ichimoku indicator works well as a directional filter. Once you see a green cloud, it means that the overall long-term trend is up. Conversely, a red cloud means that the trend is down. Furthermore, when the red line is above the blue line, it emphasizes the bullish short-term trend. And when the red line dips below the blue line, it indicates a bearish short-term trend.
During a new bullish trend, you will see that first the red line crosses above the blue line, showing that the short-term trend had changed, followed by the cloud turning green, confirming that the long-term trend is up as well.
Pullbacks, support and resistance and trend re-entries
Once the cloud and the higher time-frame confirm the overall direction of the trend, a trader can go to the lower time-frame to fine-tune his entries. To find re-entry opportunities during trends, traders usually wait for a pullback to, or into the cloud. Once price then leaves the cloud and the red and blue line cross back again into the original trend direction, it can provide re-entry opportunities.
The red shaded boxes mark the periods when price dipped into the cloud and left it again afterwards. The green arrows point to the cross of the red and blue lines, confirming that the short-term momentum went back to bullish.
The Ichimoku indicator can be combined with support and resistance principles or other trend tools and indicators. However, momentum indicators such as the RSI, the MACD or the Stochastic could provide redundant trading signals.
