Ichimoku Charting UBS FORMATION

Ichimoku Charting

An Introduction

Jason Perl

Global Head: Fixed Income, Rates & Currencies Technical Strategy Group

UBS Investment Bank

ICHIMOKU KINKO HYO : INTRODUCTION

•

Developed by Goichi Hasoda

• Outlined the theory in his book Ichimoku Charting in 1969

• Ichimoku - at a glance, Kinko - balance, Hyo - charts

• Widely used in Japan

ICHIMOKU : THE LINES

•

CONVERSION LINE

Tenkan-sen

• BASE LINE

Kijun-sen

• LAGGING SPAN

Chikou Span

• LEADING SPAN 1

Senkou Span 1

• LEADING SPAN 2

Senkou Span 2

• OPEN, HIGH, LOW, CLOSE

ICHIMOKU : DERIVING THE LINES

•

CONVERSION LINE

(Highest high [9] + Lowest low [9]) / 2

• BASE LINE

(Highest high [26] + Lowest low [26]) / 2

• LAGGING SPAN

Current price shifted back 26 periods

• LEADING SPAN 1

(Base Line + Conversion Line) / 2)

Shifted forward 26 periods

• LEADING SPAN 2

(Highest high [52] + Lowest low [52]) / 2

Shifted forward 26 periods

• CLOUD

Shaded area between Leading Span1

and Leading Span2

ICHIMOKU : INTERPRETING THE LINES

•

BASE / CONVERSION LINES

give buy and sell signals as with

regular moving averages.

• CLOUD

if today’s price > Cloud, the

implication is higher prices. Top of

Cloud represents first level of

support while bottom of Cloud is the

secondary support. If today’s price <

Cloud, the implication is lower

prices. Bottom of Cloud should then

offer initial resistance, while top of

Cloud should provide secondary

resistance.

• CLOUD DENSITY

the thicker the cloud, i.e. the greater

the distance between Senkou Span

1 and Senkou Span 2, the less likely

the probability that price will break

through the secondary level.

Breakouts are more likely when the

Cloud is very thin.

ICHIMOKU : INTERPRETING THE LINES

• LAGGING SPAN

is used in conjunction with the

current bar. If the Lagging Span is

trading above the bar of 26 periods

ago, the market is in a bullish phase.

If the Lagging Span is trading below

the bar of 26 periods ago, the market

is in a bearish phase.

The position of the Lagging Span

relative to the corresponding Cloud is

also important as it will help define

the current support / resistance levels

depending on whether it is above /

below or inside the Cloud.

In a bull market, the Cloud offers

strong support, while providing solid

resistance in a bear market.

ICHIMOKU : EUR/USD DAILY CHART - EXAMPLE

ICHIMOKU : USD/JPY DAILY CHART - EXAMPLE

In the example above, it’s interesting that although price was above all of the lines at one stage, an impulsive upside breakout was unlikely because the Cloud relative to the corresponding Lagging Span was very thick. Any bullish strategy initiated at that point would therefore have to take into account the length of time before the Cloud relative to the Lagging Span dropped away sharply to the downside. This is

Cloud is very thick relative to Lagging Span, thereby reducing likelihood of near-term upside breakout.

Price has broken Cloud but Lagging Span corresponding to Cloud is still very thick, which reduces likelihood upside break will be sustained Cloud starts to fall away sharply -highlighting the first point where an upside break is most likely to occur

Simultaneous break of Cloud support by both price and Lagging Span initiates sharp sell-off Simultaneous break of Cloud support by both price and Lagging Span initiates sharp sell-off

ICHIMOKU : USD/JPY DAILY CHART - EXAMPLE

Price violates Cloud support first but break only becomes impulsive to the downside once the Lagging Span breaks below its Cloud support.

Lagging Span violates Cloud support first but break becomes impulsive to the downside once the price breaks below its Cloud support.

Both of the examples above emphasise the need for both the Lagging Span and current price to break their respective Cloud supports to reduce the short-term whipsaw risk. In the first example, price moved lower first and the ensuing bounce prior to the break by the Lagging Span was fairly minimal. However, in the second example, where price closes above the top of the Cloud, the corresponding Lagging Span doesn’t manage to do so resulting in a sharp pullback. the Lagging Span broke Cloud support first.

Price breaks through the Cloud but corresponding Lagging Span fails to do so - ensuing failure highlights the importance of waiting for confirmation from both.

ICHIMOKU : USD/JPY - INTRA-DAY CHART

Note how Cloud relative to Lagging Span starts to fall away sharply, thereby increasing prospect of a near-term break to the upside. The fact that Leading Span 1 crosses above Leading Span 2 going forwards adds credence to this scenario.

Breakdown becomes impulsive once price and Lagging Span break below Cloud Support. Note how the Base Line subsequently becomes resistance going forwards.

ICHIMOKU : EUR/USD - DAILY CHART

Note, price breaks through Cloud but Lagging Span (which is approaching thick Cloud support fails to do so on a closing basis. Waiting for confirmation rather before establishing strategic short positions would have avoided subsequent sharp rebound.

Again, price spikes below Cloud support but the Lagging Span needs to close below its Cloud support to initiate an impulsive breakdown. Since Cloud relative to Lagging Span at that point is fairly thick, it reduces the probability of a sharp move lower at that point in time.

Both price and Chikou finally break Cloud support

simultaneously In the first two instances below (September-02 and April-03, market

sentiment towards the Euro became quite negative. However, the Cloud relative to the Lagging Span at that point in time was relatively thick and suggested that an impulsive breakdown was unlikely unless / until the Lagging Span also broke below its corresponding Cloud support on a closing basis. Waiting for this additional evidence would have avoided selling ahead of a resumption of the up-trend. Finally, downtrend accelerated when both broke simultaneously.

ICHIMOKU : DXY (CASH) - MONTHLY CHART

NOTE: At the end of November 2003, both the price and Lagging Span closed below their respective Cloud supports, suggesting further weakening of the USD over the medium-term.

ICHIMOKU : GBP/USD - MONTHLY CHART

While price had broken Cloud resistance on several occasions, it was in September 2003 that both price and Lagging Span broke their respective monthly Cloud resistances. NOTE: price and Lagging Span had not been above their Clouds since 1992.

ICHIMOKU : GBP/USD - DAILY CHART

Daily price and Lagging Span break of Cloud resistance provide early signal ahead of monthly break at end of November.

ICHIMOKU : AUD/USD - DAILY CHART

NOTE: Although price broke through Cloud support, the Lagging Span held its

corresponding Cloud support, suggesting price sell-off was most likely a false break.

ICHIMOKU : EUR/JPY - DAILY CHART

Price above Cloud resistance, waiting for confirmation from Lagging Span relative to its Cloud resistance.

ICHIMOKU : NIKKEI 225 (CASH) - DAILY CHART

Note: At the end of May 2003, both the current price and Chikou broke above their respective Cloud resistance levels simultaneously for the first time since February 2002, thereby signalling a significant breakout to the upside. Upside breaks up until that point were false breaks as price had broken without confirmation from Chikou.

ICHIMOKU : S&P (FUTURE) CONTINUATION CHART

Note how critical Cloud support has been for last 4 significant sell-offs in S&P.

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