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Learn To Trade The Ichimoku Cloud Indicator

There are many indicators out there that track and measure all kinds of things, but few are less understood than the Ichimoku indicator. With five different components that are calculated five different ways, it’s no surprise that many traders shy away from utilizing it. 

With that in mind, we felt like it was the perfect indicator to do a deep-dive study on to find out how it works and how to use it.


Ichimoku Basics

When using the Ichimoku indicator, there are a few general conditions that traders might look for when deciding to take a trade. For a bullish setup, traders might look for some or all of the following conditions to be true;

  • Price closed above Kumo Cloud (Senkou A and Senkou B)
  • Cloud must be positive (Senkou A above Senkou B)
  • Tenkan-Sen line greater than Kinjun-Sen line
  • Chikou Span line above Kumo Cloud (Senkou A and Senkou B)

For a bearish setup, traders might look for some or all of the following conditions to be true;

  • Price closed below Kumo Cloud (Senkou A and Senkou B)
  • Cloud must be negative (Senkou A below Senkou B)
  • Tenkan-Sen line less than Kinjun-Sen line
  • Chikou Span line below Kumo Cloud (Senkou A and Senkou B)

Our Initial Study

We begin our study by utilizing the strategy tester. In the first example you’ll see below, we examine the most basic version of bullish and bearish entry and exit scenarios. We performed the testing on the $SPY ETF, tested back 7,000 candles, and compared three time frames; 15m, 1hr, and 1D. For our first set of tests, we entered all bullish biased trades when all of the ‘bullish setup’ criteria was true and all bearish biased trades when all of the ‘bearish setup’ criteria was true. In order to gain a wide data set, we chose a handful of different exit scenarios.

When in a bullish trade, we tested four different exits. They were as follows:

  • Sell when price closes below the Kinjun-Sen
  • Sell when price closes below the Senkou A
  • Sell when price closes below the Senkou B
  • Sell when the Chikou Span closes below the Senkou A and Senkou B

When in a bearish trade, we tested four different exits, as well. They were as follows:

  • Sell when price closes above the Kinjun-Sen
  • Sell when price closes above the Senkou A
  • Sell when price closes above the Senkou B
  • Sell when the Chikou Span closes above the Senkou A and Senkou B

The data we got back as a result of these tests was quite dense, so we packed everything cleanly into two separate spreadsheets so it would be easy to understand. Here’s what we found.


Bullish Bias Trade Results

As you can see in the chart below, The best performing individual strategy, in terms of % return, was the Chikou Span exit on the daily time frame. Remember, this strategy directs the trader to get out of the trade when the Chikou Span closes below the Senkou A and Senkou B lines.

That said, when we take a closer look at the numbers, we find that exiting the trade when price closes below the Senkou B is actually the best performer across time frames. Using the Kinjun-Sen as an exit seems to be the weakest performer, which suggests that it doesn’t allow the trade to ‘breathe’ the same way that the alternative exits do.

Another important thing to note is the relative win rate across strategies when using the hourly time frame. This suggests that the hourly time frame might be the sweet spot for this particular strategy, regardless of the exit criteria you choose.


Bearish Bias Trade Results

Now let’s dig into the bearish strategy. We used the ‘bearish setup’ criteria to define our entry, and again, we tried a few different exit strategies. Just like for the bullish strategy tests, we used a look back period of 7,000 candles and tested this strategy on the 15m, 1hr, and 1d time frames on the $SPY index.  Here’s how it performed:

As you can see in the chart below, The best performing individual strategy, in terms of % return, was the Kinjun-Sen exit on the hourly time frame. Remember, this strategy directs the trader to get out of the trade when the price crosses up on the Kinjun-Sen line.

That said, when we take a closer look at the numbers, we find that exiting the trade when price closes above the Senkou B is actually the best performer across time frames. Using the Chikou Span as an exit seems to be the weakest performer, which suggests that it allows for too much time to elapse before the trader gets out of their bearish trade.

Another important thing to note is the win rate across all of the strategies utilizing the hourly time frame. Just like the bullish setup, this suggests that the hourly time frame might be the sweet spot for this particular strategy, regardless of the exit criteria you choose.


Alternative Bullish Strategies

As we can see in the data above, though some of the basic strategies yielded some decent returns, as a whole, we were underwhelmed with the results. In fact, none of the strategies outperformed buying and holding the asset over the same period of time. We believe this to be the case because of the time it takes for all of the bullish or bearish conditions to be true at once. We found that much of the move had already completed once all factors were true. With that in mind, we used what we learned in the above testing and dug deeper to see if we could find some other favorable strategies. In the following tests, we forego multiple timeframes and tested only on the hourly, but we did still use a look-back period of 7,000 candles.

Kumo Cloud Cross Up

Entry when:

  • Senkou A crosses up on Senkou B
  • Price is greater than Senkou A and Senkou B

Exit when:

  • Senkou A is less than Senkou B

Results

We tested this strategy because it’s a common strategy that traders utilize. As we can see in the image below, however, this strategy does not perform significantly better than the initial strategies we tested. It doesn’t quite beat out the buy and hold over the same period of time, but the returns are a favorable +35.67%. Of note, also, is the 59% win rate.

Tenkan-Sen Cross Up on Kinjun-Sen

Entry when:

  • Tenkan-Sen Crosses up on Kinjun-Sen
  • Price is greater than Tenkan-Sen

Exit when:

  • Senkou B crosses down on Senkou A

Results

Another interesting bullish strategy is buying when the Tenkan-Sen crosses up on the Kinjun-Sen and price is above the Tenkan-Sen. We see that this yields a net gain of +32.05% over the 7,000 candle period. In this case, as well, of note is the 71% win rate.

Chikou Span and Kumo Cloud

Entry when:

  • Chikou Span is Greater than Senkou A and Senkou B

Exit when:

  • Chikou Span is Less than Senkou A and Senkou B

Results

A final interesting strategy is buying when the Chikou Span gets above the Kumo Cloud and exiting when it moves below it. This strategy yielded a +49.45% gain, which is the closest we got to beating out the buy and hold return over the same period of time. However, with a win rate of 52%, it doesn’t perform as well as often as the other strategies we tested, so it might be best for a more active trader.


Alternative Bearish Strategies

In the below tests, we tested the inverse of the ‘alternative bullish strategies’ above. Here’s what we found:

Kumo Cloud Cross Down

Entry when:

  • Senkou A crosses down on Senkou B
  • Price is less than Senkou A and Senkou B

Exit when:

  • Senkou A is greater than Senkou B

Results

This strategy had a poor performance, yielding a -3.58% loss. With a win rate of only 41%, we recommend back testing some alternative exits if you’re interested in trading this strategy on this name.

 

Tenkan-Sen Cross Down on Kinjun-Sen

Entry when:

  • Tenkan-Sen crosses down on Kinjun-Sen
  • Price is less than Tenkan-Sen

Exit when:

  • Senkou B crosses up on Senkou A

Results

This strategy yields an even poorer performance than the previous strategy, netting a loss if -6.06%. Onto the next one!

 

Chikou Span and Kumo Cloud

Entry when:

  • Chikou Span is less than Senkou A and Senkou B

Exit when:

  • Chikou Span is greater than Senkou A and Senkou B

Results

Based on the results of its bullish counterpart, we had high hopes for this strategy. However, as you can see in the image below, it was the worst performer of the three with a whopping net loss of -25.63%.

What did we learn?

The first, and most obvious result that we noted was that the bullish setups seem to produce better returns than the bearish setups across all time frames. Another interesting discovery was the relative success rate and return rate on the hourly time frame. It’s clear that the hourly time frame is the sweet spot for both the bullish and bearish versions of these strategies. After testing some more refined strategies, it’s clear that the more ‘broad brush’ strategies that we tested at the beginning of this blog do hold up in comparison to more specific strategies.

On the bullish side, we like the ‘Chikou Span and Kumo Cloud’ Strategy which directs the trader to enter when the Chikou Span is above the Kumo cloud and exit when it’s below the cloud. On the bearish side, the ‘Kinjun-Sen Exit’ from the ‘broad brush’ strategy seems to be the best performer.

We hope you found this helpful, and if you have any questions, feel free to reach out to us in chat!