3 trading strategies in 1 indicator
If you want to know the state of the market at a glance, just look at the clouds…
Now, before you institutionalize me, I’m not talking about the fluffy white cotton floating in the sky.
I’m talking about Ichimoku scatter charts, a technical indicator developed by Japanese writer Goichi Hosoda in the 1930s.
I first heard about these cards at a conference in New York about a dozen years ago. The speaker said that Hosoda was so frustrated with market forecasting tools that he decided to spend his time finding something useful.
The story goes that his team rented space in a windowless warehouse and got to work. Using price data from old newspapers, they tested countless different methods to forecast market trends. (Keep in mind that this was long before the computer age and involved a lot of manual calculations.)
Then one day, the breakthrough came…
A moving average is a commonly used indicator in technical analysis. It smoothes out random short-term price movements to give you a clearer long-term trend.
But in this windowless warehouse, Hosoda realized that no single moving average provides a complete view of the market.
To do this, he discovered, you need to add “midpoints”.
The midpoint is the average of the day’s highs and lows. Using midpoints as well as different lengths of moving averages, Hosoda has created charts that show the state of the market at a glance – hence the name Ichimoku, which literally translates to “at a glance”. eye”.
Because Ichimoku clouds offer so much information, they can be intimidating for new traders.
Let’s break it down together…
Take a look at the 13 minute chart of Affirm (AFRM) below.
The buy-it-now-pay-later business came under pressure when Apple announced its entry into the market a few days ago. But the cloud chart was already bearish before the news broke:
(Click here to enlarge the image.)
The red and green areas in the graph above are the “clouds”.
The simplest interpretation is to buy when prices are above the clouds and sell when they go below.
Prices recently broke above the cloud on June 8, warning traders to be bearish on the AFRM.
Unfortunately, interpreting Ichimoku clouds is not that straightforward.
Trading cloud breaks will be lead to big gains – but only when prices are in long-term trends.
When prices are moving fast in the clouds, this strategy will result in a large number of losing trades.
That’s why it’s important to understand the other components of Hosoda’s cloud system…
Let’s get technical
There are four other main components of an Ichimoku cloud…
- A “bar” is each time period plotted on the price chart. In the chart above, a black bar is drawn every 13 minutes.
- The blue line on the chart is the turn line, or “Tenkan-sen”. It is the midpoint of the high and low of the last 9 bars.
- The red line is the standard line, or “Kijun-sen”. It is the midpoint of the high and low of the last 26 bars.
- The magenta line is the lagging line, or “Chikou Span”. This is the closing price down 26 bars.
Clouds are formed by the rotating line (blue) and the standard line (red).
The upper boundary of the cloud is the midpoint of the two lines shifted 26 bars forward. Let’s call it “A”.
The lower boundary of the cloud is the midpoint of the top and bottom of the last 52 bars shifted 26 bars forward. We will call it “B”.
The cloud is green if A is above B. It is red if A is below B.
I have already mentioned one way to interpret the graph. If the price closes above the clouds, the chart is bullish. When prices are in the clouds, the signal is unchanged. If the price falls into the cloud after a buy signal, the chart remains bullish until the price drops below the clouds, at which point it becomes bearish.
But there are other ways to trade Ichimoku Clouds. Some traders, for example, use the rotating line and the standard line for signals.
The turn line is faster, since it is calculated with 9 bars. When it is above the slower line, or the standard line, it is a buy signal. When he is underneath the slower line is bearish. This is very similar to a moving average strategy.
More conservative traders, on the other hand, tend to focus on the lagging line.
When this line crosses above the clouds, it is a buy signal. Sell signals occur when it falls below the clouds, while the time spent in the cloud is ignored. Because this line is 26 bars behind the price action, it benefits during major trends.
Many traders look for two or even three of the signals before acting. This can help identify the safest trades.
The Ichimoku cloud is a versatile market forecasting tool. Most people have heard of it before. But then they try to apply them to a chart once… get scared and quickly go back to a simpler indicator.
It’s a complicated system. Even I can’t completely explain Ichimoku clouds all at once. That’s why I’m making it a three-part series.
These cards offer a lot of information at once. It will take time to master them. But if you do, you’ll be able to spot opportunities with greater frequency.
Next Tuesday, we’ll see a detailed example of Ichimoku clouds in action…
Until there,Michael Carr, CMT, CFTE Editor, True masters of options
PS There’s a good reason I’m bringing up the Ichimoku Clouds right now.
My colleague Andrew Keene, who joined True masters of options this year commands special mastery over Ichimoku clouds. But it goes one step further by combining them with its SCAN system to find low risk/high reward options trades every day.
So far this year, Andrew has a pass rate of 71% only call options in a bear market. And soon he will show you how he does it.
You’ll learn a lot more about Andrew in the weeks to come, including his SCAN system and how it works. Keep an eye out for more details…
Chart of the day:The bear market is officially launched
By Mike Merson, Editor, True masters of options
(Click here to enlarge the image.)
Although it has been felt for months… yesterday’s fall in the S&P 500 has officially placed the beating heart of US business in a bear market.
And it just so happened that the index was placed right on a rising support line. This line acted as resistance all the way to the 2009 low, until stocks broke through it in mid-2020.
A round trip from the post-pandemic rally, while painful, seems appropriate to me. Much of the asset gains across the board were driven by money printing and quantitative easing. Now the Fed is tightening. We can confirm that “Don’t Fight the Fed” works both on the upside and on the downside.
The Fed is expected to raise interest rates by 50 basis points this week. Given the inflation numbers, I don’t think a 75 point hike is out of the realm of possibility, even if it was “out of place” at the last meeting.
With this meeting so close, I expect stocks to chop around this new low over the next two days before deciding where to settle. I’m not personally interested in the long side until we get back above 3900.
Cheers,Mike Merson Chief Editor, True masters of options