The Cloud (Kumo) is designed to represent different levels of support and resistance. Hosada (the inventor or this indicator) realized that support and resistance levels cannot remain constant, and because market participants have different levels of risk and return, therefore we must use “moving” lines along the price “moves”. The cloud is composed of two (Senkou) stretched lines, I and II, which have been displayed in a futuristic time frame (pushing them forward on the price chart) to form the shaded area between the two line.
The general theory of this indicator states that if the price is above the cloud, the general trend is to the upside, and if it was under the cloud, the general trend is to the downside. If the price was between the two (Senkou) lines, the cloud will change to another color and the Senkou lines will represent the support and resistance levels and the instrument should be traded on the assumption that prices are range trading (within the cloud), and the trend is not specified.
In addition to (Senkou), there are also three moving average curves; the first is (Tenkan-sen), which are the average of the sum of the maximum and minimum price within this period, divided by two, and (Kijun-sen), which works as (MACD) signals when it intersects with (Tenkan-sen) , and (Chinkou) which is the representation of the price today displayed 26 periods ago, which is actually the reason behind this indicator’s strength. When (Tenkan-sen) penetrates (Kijun-sen) from the bottom to the top, it is a signal to buy. If it is from the top to bottom, then it is a sell signal. There are several other interpretations for the Ichimoku Kinko Hyo indicator, and are as follows:
- When the price is higher than the cloud, the upper boundary of the cloud represents the first support level, and the lower part is a second support level, and vice versa, when the price is below the cloud, the lower part of the cloud represents the first resistance level, and the top level represents the second one.
- If the (Chinkou) curve broke through the price curve from the bottom to the top, then it’s a signal to buy. If the (Chinkou) curve broke the price curve from the top to bottom, then it is a sell signal.
- (Kijun-sen) is a market directional indicator. If the price was higher than the indicator, then prices will probably continue to rise. When price breaks through this curve, it is likely that the trend has changed.
- (Tenkan-sen) is a market movement’s indicator. If this line increases or decreases, then a trend exists, and when it is horizontal, it means that the market is trading within a range.