What Is the Ichimoku Cloud?

The Ichimoku Cloud is a collection of technical indicators that show support and resistance levels, as well as momentum and trend direction. It does this by taking multiple averages and plotting them on a chart. It also uses these figures to compute a “cloud” that attempts to forecast where the price may find support or resistance in the future.

The Ichimoku Cloud was developed by Goichi Hosoda, a Japanese journalist, and published in the late 1960s. It provides more data points than the standard candlestick chart. While it seems complicated at first glance, those familiar with how to read the charts often find it easy to understand with well-defined trading signals.

The Formulas for the Ichimoku Cloud

The following are the five formulas for the lines that comprise the Ichimoku Cloud indicator.

$\begin{aligned}&\text{Conversion Line (tenkan sen)} = \frac {\text{9-PH} + \text{9-PL}}{2} \\&\text{Base Line (kijun sen)} = \frac{\text{26-PH + 26-PL}}{2} \\&\text{Leading Span A (senkou span A)} = \frac{\text{CL + Base Line}}{2} \\&\text{Leading Span B (senkou span B)}= \frac{\text{52-PH + 52-PL}}{2} \\&\text{Lagging Span (chikou span)} = \text{Close plotted 26 periods} \\&\phantom{\text{Lagging Span (chikou span)} =} \text{in the past} \\&\textbf{where:} \\&\text{PH} = \text{Period high} \\&\text{PL} = \text{Period low} \\&\text{CL} = \text{Conversion line}\end{aligned}$​Conversion Line (tenkan sen)=29-PH+9-PL​Base Line (kijun sen)=226-PH + 26-PL​Leading Span A (senkou span A)=2CL + Base Line​Leading Span B (senkou span B)=252-PH + 52-PL​Lagging Span (chikou span)=Close plotted 26 periodsLagging Span (chikou span)=in the pastwhere:PH=Period highPL=Period lowCL=Conversion line​

How to Calculate the Ichimoku Cloud

The highs and lows are the highest and lowest prices seen during the period—for example, the highest and lowest prices seen over the last nine days in the case of the conversion line. Adding the Ichimoku Cloud indicator to your chart will do the calculations for you, but if you want to calculate it by hand, here are the steps:

1. Calculate the Conversion Line and the Base Line.
2. Calculate Leading Span A based on the prior calculations. Once calculated, this data point is plotted 26 periods into the future.
3. Calculate Leading Span B. Plot this data point 26 periods into the future.
4. For the Lagging Span, plot the closing price 26 periods into the past on the chart.
5. The difference between Leading Span A and Leading Span B is colored in to create the cloud.
6. When Leading Span A is above Leading Span B, color the cloud green. When Leading Span A is below Leading Span B, color the cloud red.
7. The above steps will create one data point. To create the lines, as each period comes to an end, go through the steps again to create new data points for that period. Connect the data points to each other to create the lines and cloud appearance.

What Does the Ichimoku Cloud Tell You?

The technical indicator shows relevant information at a glance by using averages.

The overall trend is up when the price is above the cloud, down when the price is below the cloud, and trendless or transitioning when the price is in the cloud.

When Leading Span A is rising and above Leading Span B, this helps to confirm the uptrend and the space between the lines is typically colored green. When Leading Span A is falling and below Leading Span B, this helps confirm the downtrend. The space between the lines is typically colored red in this case.

Traders will often use the Ichimoku Cloud as an area of support and resistance depending on the relative location of the price. The cloud provides support/resistance levels that can be projected into the future. This sets the Ichimoku Cloud apart from many other technical indicators that only provide support and resistance levels for the current date and time.

Traders should use the Ichimoku Cloud in conjunction with other technical indicators to maximize their risk-adjusted returns. For example, the indicator is often paired with the relative strength index (RSI), which can be used to confirm momentum in a certain direction. It’s also important to look at the bigger trends to see how the smaller trends fit within them. For example, during a very strong downtrend, the price may push into the cloud or slightly above it, temporarily, before falling again. Only focusing on the indicator would mean missing the bigger picture that the price was under strong longer-term selling pressure.

Crossovers are another way that the indicator can be used. Watch for the conversion line to move above the base line, especially when the price is above the cloud. This can be a powerful buy signal. One option is to hold the trade until the conversion line drops back below the base line. Any of the other lines could be used as exit points as well.

The Difference Between the Ichimoku Cloud and Moving Averages

While the Ichimoku Cloud uses averages, they are different than a typical moving average. Simple moving averages take closing prices, add them up, and divide that total by how many closing prices there are. In a 10-period moving average, the closing prices for the last 10 periods are added, then divided by 10 to get the average.

Notice how the calculations for the Ichimoku Cloud are different. They are based on highs and lows over a period and then divided by two. Therefore, Ichimoku averages will be different than traditional moving averages, even if the same number of periods are used.

One indicator is not better than another; they just provide information in different ways.

Limitations of Using the Ichimoku Cloud

The indicator can make a chart look busy with all the lines. To remedy this, most charting software allows certain lines to be hidden. For example, all of the lines can be hidden except for Leading Span A and Leading Span B, which create the cloud. Each trader needs to focus on which lines provide the most information, then consider hiding the rest if all of the lines are distracting.

Another limitation of the Ichimoku Cloud is that it is based on historical data. While two of these data points are plotted in the future, there is nothing in the formula that is inherently predictive. Averages are simply being plotted in the future.

The cloud can also become irrelevant for long periods of time, as the price remains way above or way below it. At times like these, the conversion line, the base line, and their crossovers become more important, as they generally stick closer to the price.

The Bottom Line

In order to create a “cloud” to show where prices may find future resistance or support, the Ichimoku Cloud plots multiple averages on a chart. This shows not only support and resistance but also trend direction and momentum, all of which appear as a group of technical indicators. While there are some limitations to the Ichimoku Cloud, it is neither better nor worse than existing technical indicators such as moving averages. It simply represents information in a different way.

What Is the Head and Shoulders Pattern?

A head and shoulders pattern is used in technical analysis. It is a specific chart formation that predicts a bullish-to-bearish trend reversal. The pattern appears as a baseline with three peaks, where the outside two are close in height, and the middle is highest.

The head and shoulders pattern forms when a stock’s price rises to a peak and then declines back to the base of the prior up-move. Then, the price rises above the previous peak to form the “head” and then declines back to the original base. Finally, the stock price peaks again at about the level of the first peak of the formation before falling back down.

The head and shoulders pattern is considered one of the most reliable trend reversal patterns. It is one of several top patterns that signal, with varying degrees of accuracy, that an upward trend is nearing its end.

Understanding the Head and Shoulders Pattern

A head and shoulders pattern has four components:

1. After long bullish trends, the price rises to a peak and subsequently declines to form a trough.
2. The price rises again to form a second high substantially above the initial peak and declines again.
3. The price rises a third time, but only to the first peak level, before declining again.
4. The neckline, drawn at the two troughs or peaks (inverse).

The first and third peaks are the shoulders, and the second peak forms the head. The line connecting the first and second troughs is called the neckline.

Inverse Head and Shoulders

The opposite of a head and shoulders chart is the inverse head and shoulders, also called a head and shoulders bottom. It is inverted with the head and shoulders bottoms used to predict reversals in downtrends. This pattern is identified when the price action of a security meets the following characteristics:

• The price falls to a trough, then rises
• The price falls below the former trough, then rises again
• The price falls again but not as far as the second trough
• Once the final trough is made, the price heads upward toward the resistance (the neckline) found near the top of the previous troughs.

Of these, the second trough is the lowest (the head), and the first and third are slightly shallower (the shoulders). The final rally after the third dip signals that the bearish trend has reversed, and prices are likely to keep rallying upward.

What Does the Head and Shoulders Pattern Tell You?

The head and shoulders pattern indicates that a reversal is possible. Traders believe that three sets of peaks and troughs, with a larger peak in the middle, means a stock’s price will begin falling. The neckline represents the point at which bearish traders start selling.

The pattern also indicates that the new downward trend will likely continue until the right shoulder is broken—where prices move higher than the prices at the right peak.

Advantages and Disadvantages of the Head and Shoulders Pattern

Advantages Explained

• Experienced traders identify it easily: The pattern is very recognizable to an experienced trader.
• Defined profit and risk: Short and long entry levels and stop distance can be clearly defined with confirmation openings and closings.
• Big market movements can be profited from: The timeframe for a head and shoulders pattern is fairly long, so a market can move significantly from entry to close price.
• Can be used in all markets: The pattern can be used in forex and stock trading.

Disadvantages Explained

• Novice traders might miss it: The head and shoulders pattern may not present with a flat neckline; it may be skewed, which can throw off new traders.
• Large stop loss distances possible: Large downward movement over long timeframes can result in a large stop distance.
• Neckline can appear to move: If the price pulls back, the neckline might be retested, confusing some traders.

The Bottom Line

The head and shoulders is a pattern used by traders to identify price reversals. A bearish head and shouders has three peaks, with the middle one reaching higher than the other two. It indicates a reversal of an upward trend.

A bullish head and shoulders has three troughs, with the middle one reaching lower than the other two. It indicates a reversal of a downward trend.