The Ichimoku Cloud

Still growing amongst the Western and European traders, the Ichimoku Cloud (or Ichimoku Kinko Hyo = One Glance Balance Cloud Chart) was originally developed pre-WWII by a man named Goichi Hosada.  Because of the war, his research was halted and then later finished in 1968 whereby he published a 1,000 page, 4 volume body of work releasing the Ichimoku Cloud to the world under the pen-name Ichimoku Sanjin.

Originally built for the Japanese stock markets, the indicator has made its way out of the land of the Eastern sun and into the trading world at large, being applied and used widely in the Commodities, Futures, Options and Forex markets.   Part of its success is its ability to find trends and reversals well before they begin.

The Indicator

The Ichimoku Cloud has several components which give it a lot of versatility and uses.  The most unique aspect of the indicator is its ‘Kumo’ or cloud which offers a unique perspective of support and resistance.  Most western methods look at support and resistance in a linear fashion or as straight lines in the sand (e.g. Fibonacci, Pivots, Channel Lines, Trend Lines).  However the Kumo or cloud is an ever evolving object which was designed to represent support and resistance based upon price action.  Generally, when you are in a strong upward trend, the support is strong as the price levels below have been accepted.  The same goes for a strong downtrend and having more layers of resistance.  Below are two examples of up and downtrends - showing how the Kumo was quite thick in nature.

The most important way to look at the Kumo is as support and resistance - meaning if it is thick, then the support/resistance (depending upon where price is in relationship to the cloud) is strong.  If price is above the Kumo, we are in a general uptrend or would want to look for more buying opportunities.  If price is below the cloud, it is below resistance (the Kumo) and we want to be searching for more shorts than longs.  The longer price stays below/above the cloud, the stronger the trend we are in and the more support/resistance the Kumo will offer.

Kumo Composition

There are two main lines of the Kumo which are referred to as Senkou Span A and Senkou Span B.  For the purposes of efficiency, we will refer to them as Span A and Span B.  The space or value in between these two lines is what forms the Kumo.

Span A is formed by taking the Tenkan Line and adding it to the Kijun Line (white and red lines respectively from chart above), then dividing that value by 2 and plotting it 26 periods ahead.  The formula is;

(Tenkan Line + Kijun Line) / 2 placed 26 periods ahead

Span B is formed by taking the highest high (over the last 52 periods), adding to it the lowest low (over the last 52 periods), dividing that by 2 and plotting that 26 time periods ahead.  The formula is;

(Highest High + Lowest Low for the last 52 periods) / 2 and plotted 26 time periods ahead.

We will talk about some important points regarding the construction of the Kumo later.

Other Ichimoku Components

(Tenkan, Kijun and Chikou Span Lines)

The Tenkan Line or Tenkan Sen (Sen means line in Japanese) is known as the conversion line or turning line is similar to a 9SMA but actually is quite different.  Remember a SMA (simple moving average) will smooth out all the data and make it equal but the Tenkan Line will take the highest high and lowest low over the last 9 periods.  The explanation for this is Hosada felt price action and its extremes were more important than smoothing any data because price action represented where buyers/sellers entered and directed the market, thus being more important than averaging or smoothing the data out.  As you can see by the chart below, the Tenkan Line is quite different than a 9SMA.  Because the TL (Tenkan Line) uses price instead of an averaging or the closing prices, it mirrors price better and is more representative of it.  You can see this when the TL flattens in small portions to move with price and its moments of ranging.

Akin to all moving averages, the angle of the Tenkan line is very important as the sharper the angle, the stronger the trend while the flatter the Tenkan, the flatter or lesser the momentum of the move is.  However, it is important to not use the Tenkan line as a gauge of the trend but more so the momentum of the move.  However, it can act as the first line of defense in a trend and a breaking of it in the opposite direction of the move can often be a sign of the defenses weakening.

The Kijun Line (or Kijun Sen) is known as the datum line, standard line or trend line designed to indicate the overall trend for the instrument or pair.  The formula behind it is the same as the Tenkan line using price action and the highest high + lowest low with the only change being in the periods as it does it over the last 26 periods.

Why 26 periods?  The answer to that is a matter of history.  When the Ichimoku was first created, the Japanese markets were open 6 days a week on Saturdays.  If the markets are open 6 days a week, this generally results in 26 trading days for the month - hence 26 periods for the Kijun.  In essence, what it was meant to be was a measure of the highest high + lowest low for the last month of price action.  If the Kijun has been climbing - it means price has been gaining ground for the last month.  If it is flat, then it will be the midpoint of the range of price for the last month of price action (or representative of the price equilibrium).

Also like the Tenkan Line, the angle of the Kijun is reflective of the overall trend in place.  Price breaking the Kijun after being in an up/down trend often has serious consequences for that trend and can many times lead to a reversal of sorts.  Ultimately because it uses a longer period to measure price action, its a more stable method for determining the direction of the trend than the Tenkan Line.  Because of price to respect this line during a strong trend, it can potentially be used as a stop loss for traders already in the correct direction of the trend.  Hence, when price breaks or closes below it by a significant amount, the trend is often over.

The Chikou Span or lagging line is created by taking the current closing price for the instrument and shifted 26 time periods back, hence why it is a lagging line.  This is a strange concept and not something usually seen in technical indicators which makes the Ichimoku Cloud even more unique.  The purpose is simply to gain perspective in regards to how the current price action is in relationship to previous price action.

The main application for giving perspective to the trader is how does the Chikou Span relate to price 26 periods ago.  If the Chikou Span is lower than price 26 periods ago, then there is resistance for the current upmove or pressure which could force price down into a bearish move.  However if the Chikou Span is above price from 26 periods ago, then it would mean there is little or no resistance ahead since price is in the process of making new highs and there is no recent price above it - thus paving the way for a strong trend.

Applications for the Tenkan and Kijun

The most common usage of the Tenkan and Kijun are the ‘cross’ or what we call the TKx (Tenkan-Kijun Cross).  Similar to how a MACD uses a cross of its two lines, the Ichimoku Cloud does the same.  It is interesting to note that the Ichimoku uses the same periods as the MACD, however it was created over a decade earlier.

One of the main signals for Ichimoku traders, the TKx can often indicate when a trend is about to begin by forming a cross (upward cross = possible upward trend while downward cross = possible down trend).  A generic upward cross can be used as a bullish signal (or exit for people already short) and a generic downward cross can be used as a generic bearish signal (and vice versa for current bulls).  However, notice we used the term ‘generic’ meaning there is more to the cross.

Hosada was able to give a further definition to the cross based upon its position to the Kumo or cloud.  If the cross was below the Kumo, then it was considered a ‘weak’ signal since the cross was below the Kumo or below resistance.  A medium signal was when a cross happened inside the Kumo as it was occurring within the field of support/resistance.  A strong signal was when the bullish cross happened above the Kumo as it was happening after clearing resistance.  The opposite is true for bearish signals whereby a weak signal is a cross above the Kumo, while a medium signal is inside the Kumo and a strong signal below the Kumo.  One important reminder to all this is to make sure you reference the Chikou Span to see how current price is in relationship to previous price action.

The nature of the cross usually indicates the overall strength or potential for the move but it should be noted strong trends have developed from weak crosses.  It is always also important you reference the construction of the Kumo when trading the typical TKx signals.

Some Important Final Notes on the Kumo

As we talked about before, the Kumo is designed to represent support and resistance but it has a host of implications in doing such.  To review, the thicker the Kumo, the stronger the support/resistance it will offer.  Price will often reject off of the Kumo only to resume the current trend as depicted below by a few examples.

What this also means is if the Kumo is exceptionally thin, in a ranging market it likely means the range will continue as their is neither enough support or resistance to hold a single direction for the pair.  What it also means is if we are in a current trend and price is approaching a thin Kumo, the chances increase for a trend reversal since the support/resistance offered by the Kumo is not significant.  This is why Kumo analysis is important as it can often lead to reversals and inform us in the future of pending trend changes.

Also, there is a common formation in the Kumo called the ‘flat top or bottom‘.  This refers to when the Span B becomes flat.  Remember the Span B is composed of the last 52 candles absolute highest high and lowest low - thus referring to price action over the last 52 periods.  If Span B is flat, the only way it can do that is if price has not extended to make any new significant highs or lows.  This means we are in a range and the tendency of a range is to move towards equilibrium or towards the center of the range - also known as the value area for price.  The end result is during a ranging environment, the Span B is the virtual 50% fibonacci retracement level for that range and is the ever changing 50% fib level for a trending environment, dividing the last 52 candles into two halves, the upper and lower half.

What does this mean for traders?  If price is inside the Kumo, it will have a tendency to gravitate towards the flat top/bottom.  If price is above it, the tendency of price will be to gravitate towards the flat top/bottom, often using it as a springboard for a rejection off of it.

Lastly, one of the most important things about the Kumo is what happens when price breaks it.  If we have been in a strong trend for sometime and price then breaks the Kumo, it usually represents a trend change and the likelihood of a large move about to begin in the direction of the break as you can see by the examples below.

It is because the Kumo is always changing shape that it can represent a much better perspective of support and resistance.  It is essentially based upon price action and changing shape based upon previous price moves.  This makes it a little more sensitive and representational to price unlike static forms of support and resistance (fibonacci retracement levels, pivots, trend lines, etc) which do not move at all once they are in place.  It is its unique construction which allows the Kumo to be both Static and Dynamic in giving support/resistance levels to the trader.

In Closing

This is just the beginning of the Ichimoku Cloud and designed to give the trader an introduction to the key elements around such a fascinating indicator and method for trading the markets.  The Ichimoku Cloud has the ability to detect trends, reversals, support/resistance levels, trend strength/weakness and momentum for a pair.  It is due to its ability to be used in multiple environments, along with its unique perspective upon price and support/resistance levels that Institutional and retail traders have gravitated towards using this method.  For more information and systems to trade the Ichimoku Cloud, take a look at the Advanced Ichimoku Course.

Chris Capre is the current Fund Manager for White Knight Investments. He specializes in the technical aspects of trading particularly using Ichimoku, Momentum, Bollinger Band, Pivot and Price Action models to trade the markets. He is considered to be at the cutting edge of Technical Analysis and is well regarded for his Ichimoku Analysis, along with building trading systems and Risk Reduction in trading applications. For more information about his services or his company, visit http://2ndskiesforex.com

What is Price Action and why we should learn it?

As forex traders, we have the challenging task of trading to make profit from the price moves in the market.  This entails finding the where (price), when (timing), and the direction (trend).  Most traders end up searching the savannah of trading systems which often have tons of indicators on the charts that end up looking like an italian spaghetti food fight amongst 5 year olds.  However, what is interesting is that the answers to these three things we have to find as forex traders (where, when and direction) are all written in the price action.  With that being said, we should answer the question of what price action is.

What is Price Action?

Price Action is simply the movement of price over time.  It can be as simple as one price candle or over 100’s.  It is not time specific but it simply refers to the movement of price due to the order flow of the market.  The bedrock of it is the forex market moves because of the big players.  Whatever the reason (technical or fundamental), the market only moves because the larger players buy and sell.  The combination of all the buy and sell orders, along with the volume is what moves the market.

Unfortunately we do not have access to the total aggregate volume in the Forex market and any broker volume we get is just a small lily pad in the pond – not representing much in terms of the overall gestalt of volume.  Thus, since we do not have access to order flow and volume, the bottom line is we have to trade the way the big players do.  We have to find out the where, the when and the direction they are getting in.

The good thing about this is we have most of this information right in front of us hidden in the price action.  Again, the market only moves because of order flow and its closest relative we could ever court is Price Action.  By learning how to read price action successfully as forex traders, we give ourselves the most important piece of information about what the big players are doing and thus can profit from these moves.  As the smaller and medium sized traders, we are simply having to learn how to surf the waves of price created by the bigger ships in the ocean of price movement.  Learning how to read price action will be the most powerful tool you could ever develop when it comes to learning how to trade because it gives you the three most important things to trading (the where, the when and the direction).  It is only until you master all three of these will you see consistent profits with minimal drawdowns over time.  Thus, get an education in price action and learn how to trade the  markets successfully.

What is an Inside Bar?

A somewhat common but important price action behavior, and Inside Bar is a candle that is completely inside the previous candles high and low.  This is not just referring to the body, but the wicks as well being inside the previous candles price action.  Why are inside bars important and how can they lead to trading opportunities?

Before we answer the question above we have to look into the reasons why this price action behavior takes place.  There are several reasons for the inside bar forming, many of which we will list below;

-Price is consolidating after a large up/down move in price and is about to start another leg in the same direction

-Price is coming up against a critical support/resistance level which shows some hesitation in the market as to whether it will continue or not

-Price Action and liquidity is dropping before a critical news announcement so with nobody taking new positions, price will not have enough order flow to move consistently in one direction

-Profits are being taken

Regardless of what the reasons are, as traders we are most concerned with which situations are most likely to yield a price action trigger and a trading opportunity.  Out of all the reasons listed below (and there are more) the least important is the news announcement as the environment leading up to a news announcement is generally recommended to be avoided due to poor liquidity.

However, all the others are critical for us because they tell us via price action what the market has done and is likely to do next via a price action trigger.

With that being said, lets look at a few inside bars and see how the price action leading up to them revealed information about why they were created and what is the likely next move.

Below is another price action Inside Bar coming at a critical resistance level.  See how the rejection on the 2nd attempt as it could not muster a close but only a wick at the previous resistance level?  The next candle is an inside bar (not making any higher highs) and closes below the mid-point of the prior blue candle suggesting the bears are starting to wrestle control from the bulls.

Another example of how price started a strong move and then formed a single inside bar.  Price then barely made a new high (with the small wick to the upside on the next red candle) and then broke the low dropping another 300+pips.  This is a common price action trigger after the formation of an inside bar.

Inside bars form approximately 10% of the time (or are approximately 10% of all candles) and are a unique price action formation. When they occur and critical support/resistance levels (prior highs/lows, Fibonacci retracement levels, outer pivots, larger Kumo formations, etc) they have more impact and can often lead to strong price moves.  Also watch out for Inside Bars occurring after a strong price action move.  By analyzing the prior move, the wicks of the inside bar, the overall size of it and the price action of the next bar following the inside bar, we can gain an insight into the price action and where the next move is likely to be.  For more information on how to trade inside bars, take a look at the Advanced Price Action or ProForex Course where we talk about price action triggers and how to trade them.

Trading the Open and Close of the Candle

When trading price action or using price action triggers such as Pbars, Inside Bars, Shaved Bars, etc. it is important to always wait for the bar/candle to close more than anything else.  Many people have challenges trading any system because the signals are forming in real time and not necessarily when the candle closes so you have moving elements to the candle, trigger and price action which are still in play.

The way around all this is to wait for the candle to close.  Once a candle has closed, it is final – it cannot ever be changed and it will always be that way.  If you are ever tentative about taking a trade, wait till the candle fully forms and closes.  Once it does, it will always be like that forever and cannot be changed.  This means the signal is clear and there are no changing components to it.

Also, one important thing about trading price action and waiting for the candle closes.  It is often the case (whether it’s the daily chart, 4H, hourly, etc) that price action will be dominant in one direction for the majority of the candle only to reverse strongly at the end of the candle.  Institutional traders know retail traders are less disciplined than they are.  They know a good candle could be forming and will often trap traders into believing that candle is an engulfing candle or reversal candle and then quickly move price in the last minute or 5minutes of the candle only to change it drastically with traders stuck or trapped into a certain direction hoping for higher/lower prices.

It is also often the case the markets will reverse at the end of a session or major candle as traders are paring back positions before market close as they want to be flat going into the close.  When they do this, if the market was moving heavily bullish for the day, you will often see price dip a bit in the last 30minutes or less of a session as the institutions are going flat into the close.

Furthermore, a lot of trading today is done via algorithms which will often as well exit their positions causing strong spikes in price going into market closes.  You can often observe this in the US equities markets as traders eliminate risk by not holding positions overnight to avoid the risk.  Another example is in the London close as you will often see a strong push at the end to only see if fade just before or even perhaps just after the market London close.

Such price action patterns are common and by waiting for the candle to close, you are trading off real price action triggers.  If the candle is still forming, unless your system is specifically tailored to getting in mid-candle, it is often recommended to wait for the candle to close because up till that point, anything can happen and the formation of the candle and price action signal can change drastically.

Lastly, if something is strong into the close, once the candle closes, it often displays the final intentions of the market in the current move.  Closes towards the highs/lows of a candle often indicate there is little profit taking so if you are trading in the direction of such a move, this can be a good confirmation sign.  However if you are in a long position and the candle closes with a strong rejection/wick on the topside, the closing of that candle could be indicating the markets intentions to reverse it as price failed for that candle to maintain a strong high and close.

Thus, its always important when trading price action to look at candle closes and entering on them as much as possible.

Candlestick Patterns and learning how to read Price Action

There are many tools to trading and reading price action. One of them that has been around for centuries are candlestick patterns. Originally used for rice trading in Japan, candlestick patterns have become very popular in global trading. However, they can be confusing with all the names, formations, strategies, etc. Ironically, most of them are not important, not frequent enough or do not produce enough good signals. That is why its important to understand which ones to focus on and which ones are not worth knowing.

In the book ‘Encyclopedia of Candlestick Patterns’ by Thomas Bulkowski, he analyzes over 1000 candlestick patterns and found that only 7 came about frequent enough and carried enough accuracy in their signals to be used in trading. Thus its important to forget about all the exotic patterns and just focus on those seven. However, there is a much more effective method than learning these patterns, and that is learning how to read price action.

The bottom line is a market is not going to move because of some candlestick pattern or some exotic name coming down from the Japanese heavens giving us some divine reason to trade. The market moves only due to order flow. Regardless of why traders buy and sell, it is the collective order flow and its balance or imbalance which moves the market. Since as traders we do not have access to order flow, its important to learn how to read price action which is far more simple than learning patterns. Why?

Because the patterns do not communicate much information about the market and are only relevant when they are fully formed. However, price action is constant and its effects, reactions, responses, formations, creations, etc are on going. Thus, if you learn how to read price action, you are essentially reading the order flow behind what created the price action.

When you learn how to read this, you will find;

Strength of buying and selling

Where the market is buying and selling

How fast or slow the market is selling

Whether there is commitment or lack thereof in the market

Whether there is balance or an imbalance in the market

And where the market is likely going to be bought or sold in the future

There are many price action formations, such has inside bars, outside bars, Pbars, etc. All of these patterns or bars communicate all the information listed above. Remember,

When trading there are only three things you are trying to find to make successful trades;

1) location – where the market is likely going to be bought or sold

2) direction – where the institutionals are pushing the market

3) time – when is the most likely time they will buy or sell the instrument

If you can figure out three of these things, your trades will likely be profitable. Trading is simple, but not always easy. Its simple because all you have to do is find these three things. The purist way to detect all this information is in price action and learning how to read price action. If there was one other tool which would be useful in combining with price action for day trading, that would be pivot points. Learning how to trade price action in combination with pivot points are two of the most powerful ways to approach the market. Pivot points solve one of the problems in trading – finding location. Direction is not hard to find as once you learn how to read impulsive or corrective moves, you can solve the direction puzzle. The last is time and this also can be discovered via price action, learning how to read price bars/candles, and learning advanced price action formations. To learn how to read price action, advanced price action formations or use pivot points, then check out the Advanced Price Action or ProForex Course where you will learn proprietary rule-based price action and pivot point systems based upon 10-30years of quantitative proprietary data.

Trading Flag Patterns

One of the most common patterns available in the market is the ‘flag’ pattern which usually occurs after a good price move. The chart below shows it visually but after a strong down/upmove, the pair consolidates sideways forming a flag-like pattern as it finds a floor or ceiling within a small range. See below.

Looking at the flag pattern above, this looks like a good one where we should trade the breakout of the flag range with a bias for an upside move. However, looking at the chart below…

The traditional method in trading this pattern is to trade the breakouts either to the upside or the downside, however there is one inherent problem with this method is that it does not consider the days price action range before taking this breakout trade.

It is understandable why traders would see this price action setup and trade the breakout as the tight range will have to give way. However, if the flag or range is happening in the middle of the days range, then it will have to fight through the rest of the price action from the days range before it actually breaks any significant support or resistance. Why?

Because yesterdays highs/lows are considered to be some of the most important support or resistance levels for institutional day traders. They constitute the levels of buying and selling both accepted and rejected by the market for the entire day. These levels were backed by millions, if not billions of dollars accepting the value areas of the price action or the rejection areas where price could not maintain any significant amount of time there. Thus, if a flag pattern occurs in the middle of the days range, say after making a good high or low on the day but encountering a strong push away from such a high or low, then falls off sharply only to produce a flag pattern in the middle of the range, price will still have to break the days’ high or low before it clears major support or resistance. Thus, it is always suggested to avoid these types of flag patterns and look for more optimal environments to trade flags.

Although they are a common price action formation, you cannot trade all flags the same – many are better or more optimized than others and when you consider the price action of the entire day, including its highs and lows, one can see more optimal flags to trade.

To learn more about the advanced price action techniques, methods and systems which teach you how to trade flags and other high-probability patterns, you can check out the Advanced Price Action or  ProForex Course.

Amplifying Price Action Signals

By themselves, price action signals can be very potent methods to trade the markets.

However, when combined with a confluence of sorts, they amplify the potency of the signal drastically. This goes for any trading strategy – when you combine it with something else which is different but confirms the same thing – chances are the signal

is more likely to produce a good trade.

The question then becomes what to combine a price action signal with? The key here

is to select from one of the 5 categories of indicators;

1) volume/volatility (e.g. ATR, Bollinger Bands, Awesome oscillator, etc)

2) momentum indicators (Rate of Change, Momentum, etc)

3) oscillator category indicators (MACD, RSI, etc)

4) trend indicators (moving averages)

5) support/resistance indicators (Fibonacci, Pivot Points, etc)

Out of all the 1 to 1 pairings you could use, there is no right answer, however some tend to be more effective and simple than others.

the first three (volume, momentum and oscillator) indicators generally require more interpretation to enhance or amplify the price action signal. However, #’s 4 and 5 (trend indicators or support/resistance indicators) tend to be more simple while giving additional information.

The benefit of using a trend indicator is it can confirm you are in the right direction or give you a good target. A 20ema can be used for this as it works well on any time frame and is probably the most balanced EMA out there. It can also double as support/resistance since the 20EMA is often watched by institutional traders and used as an entry point to get into the market. The other good thing about it is its simple and not complicated to use so it works well with price action trading.

The other method is to use support/resistance indicators such as Fibonacci retracements or pivot points. Of the two, pivot points are more powerful and have more contact with price than Fibonacci levels do. However, Fibonacci levels can work really well for entries and exits but its important to note Fibonacci traders do not use these levels by themselves and always add other confluence indicators to support their signals.

Hence, when trading price action, its important and can be useful to learn another tool to confirm or amplify your signal such as the 20ema or Pivot Points. To learn how to combine them all together, you can check out the Advanced Price Action or  ProForex Course which teaches simple high-probability strategies to put them all together and enhance your price action trading.

3 Keys to Successful Trading

Three of the most important things you could do to trade this market successfully:

Review your work
Practice through Repitition
Trade with a Plan

1) You will likely make 100’s of trades, 1000’s, perhaps 10’s of thousands of trades if you stay in the game long enough and become successful. If you do not review your trades, you will never really remember what mistakes you made and how to correct them/avoid them in the future. All professionals at every level review what they did to see their mistakes and not make them again.

Professional football players watch hours of tape to see what worked well and what did not. Musicians listen to the sounds they make. Professional fighters watch themselves and other fighters to find out their strengths and weaknesses.

This variable is common amongst all professionals – review your work periodically and consistently. Only then can you learn from your mistakes.

2) Repetition is key. Practice anything long enough, consistently enough, and it can be learned and learned well. It becomes a part of your nervous system and something you can just do without thinking.

Martial artists practice something called ‘forms’ which are specific movements that underlie all the basic movements of everything they are doing. These forms are practiced for hundreds of hours again and again to make sure what they are doing is known so well, it becomes automatic. This has to be the goal for the developing trader – to practice something (a method/strategy = Price Action, Ichimoku, Pivot Point Trading, etc.) so many times, thinking is out of the process and you are just doing it through pure practice.

This leads you as the trader to enter what is called ‘the zone’ where you step outside thinking about what you are doing and you just do it. Musicians, athletes, poets, artists have all experienced this. But this is not something that comes naturally or easily. It takes hundreds of hours of practice doing something. Once the skill is learned, then you have to work on letting go. But first comes the practice.

Only by practicing trading the same method over and over and over will you learn its ins and outs, will you learn its strengths and weaknesses, when to trade it and when not to. The point of trading is not to be able to trade everything – the point of trading is to make money consistently. Only greed and thoughts of the future focus on ‘how much’ to make or ‘can be made’.

Make good trades and the money will come. However to make good trades, you have to have a method or a system which is clear, simple and easy to follow. There are many of these out there;

Price Action Methods

Ichimoku Systems

Pivot Point Systems

Find one that is simple and easy for you learn, then practice it until you got a working mastery of it. Then you can wield it well and make consistent profits from the market.

3) Trade with a plan. As the saying goes, “If you are trading without a plan, you are planning to lose”

The intelligence of this statement is actually supported by the two previous keys we talked about. How can you learn from your mistakes if you are constantly doing something different? How can you gauge what you are doing is working? How could a scientist test the results of their work? How could Michael Phelps (Olympic Gold Metal Record Holder) ever know if his swimming techniques were working if he used a different stroke every time he got in the pool? There is no way to know.

Thus, you have to trade with a plan and follow that plan with discipline. How do you know if you are doing this?

-Do you use the same entry parameters to get into a trade?

-Do you always follow the risk management rules for the system?

-Do you have a list of setups you will trade or will not trade?

-Do you have a list of environments/pairs/time frames you will use and will not?

-Do you ever step outside of these rules?

If the answer to all of these questions above is ‘Yes’, then you have a plan and are trading it with discipline. Pat yourself on the back – you deserve it because most who enter this arena do not.

If the answer to any of the above questions is ‘No’, then you are not. There is no negotiating here. The market will not negotiate with you. The market does not care about you and whether you are disciplined, following proper risk management, using your Price Action Methods or not. If you want to do anything professionally, you have to follow the discipline.

Find an Olympic athlete that does not practice intensely or follow a discipline. Find a professional concert pianist who does not do this. You will not. Yet, you want to be a professional forex trader. If so, then find the common elements of all highly skilled professionals and learn them. What do all of them have in common? The three elements listed above.

All review their work, all practice the methods with a lot of repetition, all have a plan and follow it.

One last point regarding a trading plan; having a trading plan keeps you accountable. Once it’s on paper and you’ve agreed to it, there are only two outcomes; either you keep to the discipline or you do not.

By keeping yourself accountable, you keep yourself focused and disciplined. Highly skilled managers do this with their employees. They keep them accountable and they keep them focused. This has to be important for you as a trader – having something to keep you accountable.

Most make the mistake of entering this market looking for ‘the system.’ They feel if they have ‘the system’, they will make money and can be successful. How could they be if they do not follow the rules, have a trading plan or practice it intensely? There are plenty of race car drivers with fast enough cars to win races, but not all do. Why?

Because the ones who win races practice, the ones who win races follow the discipline, the ones who win races review their work.

By learning the 3 Keys to Successful Trading, you put yourself on the short path to success but it does not come easy. As one trader said very well, ‘Trading is simple, its just not easy.’ Make sure you incorporate the 3 keys to successful trading and you are on your way. The next step is to find someone who can help you get there. A mentor or guide will accelerate the process. The other important thing is to find a method which is simple to learn, easy to implement, and works well in the market.

There are systems and methods which have worked for years across all markets. Some of them are;

Price Action Methods

Ichimoku Systems

Pivot Point Trading

There are thousands of traders throughout the last 100 years which have used these systems and made millions of dollars doing so. And there will be more again. The oldest of all of them are the Price Action Methods which are some of the most pure/simple methods to trading all markets. If you want to learn how to trade these methods, then check out our Advanced Price Action or our Advanced Ichimoku Cloud Trading Course where you will learn simple high-probability rule-based systems and setups to trade these markets successfully.

Using Rejections and Price Action to Confirm your Reversal Entry

Reversals are one of the most common elements in markets traders are wanting to either know of to avoid or confirm their trade. The clues to whether a reversal is in play are hidden in the price action and easily found. These key elements are found in rejections which show up in the price action formation of long wicks occurring at key price levels.

Starting with the Rejection Wicks

The key point in a candle which confirms a rejection at a key price level is a wick and the larger the wick, the better. With that statement comes the question of ‘how much or how large the wick should be to be considered a strong wick.’

The answer to this question would be a minimum of 50%. Why?

Because this is the minimum amount to satisfy the condition that one side of the market does not have more control than the other. Think about it like this. If price is in an uptrend and starts to approach a key price level, once it touches this key price level now creates a wick which reverses 50% of the price advance of say a 4hr or daily candle, this 50% rejection means the bears were able to stop the upward force/momentum of the current uptrend and 4hr/daily candle, but were able to push prices back 50% of that candle and move. This would translate into the bears having at least as much strength on the board in terms of order flow than the bulls because they were able to take half of the gains and eliminate them.

In some sense, it would actually translate into more strength because they also had to stop the momentum which was already upward. Thus, to stop momentum on any moving object takes energy and force. This then translates into there being the minimum requirements for a reversal for it demonstrates the bears have the minimum energy and force to reverse the trend.

Obviously the larger the wick the better because if the bulls who have the current handle on the market run into some sell orders and are not only unable to keep advancing price, but get pushed back quite a strong amount, this means the bears have taken short term control of the market and this can be seen in the price action.

Remember, a wick is a rejection of price. If price was accepted at a certain level, it would stay there or advance past it. However, if the order flow in the market does not support price being at that level, it will reject it and send it back because the institutions would be finding that price over-valued and time to sell. This is what it means when we say a wick is a rejection of price action.

Using them at Key Price Levels
This is the trickier part of your assignment – finding the key price levels. However with a few simple tools, its not that hard to confirm. We will suggest three tools to help you confirm the reversal is happening at a key price level.

Before we do, its important to note this works better on time frames such as the 4hr and daily charts. Anything below this does not contain enough time to signify an important impact on the market. Thus, when we are talking about these, we are referring to the 4hr or daily charts.

1) Pivot Points – key price levels that are respected and watched by all institutional traders, when strong price rejections occur at key pivot levels, they often have more impact. Why? Because institutions place intraday orders around pivots more than anything else. They enter the market at these locations more than they do any other price levels so when we see price reject strongly off a pivot point – it usually has more impact.

Taking a look at Exhibit A below, we can see how the price action had a pretty strong intraday rejection off of the M3 pivot level at 1.0366. This was the highest price surge for any candle on this trading day and it rejected back down below the daily pivot to stop where? At the M2 Pivot showing you the market is respecting these two pivot levels.

The fact that this pivot also happened to line up with a lot of the support for the candles to the left along with the swing low all the way to the left of the chart at the same price level shows this to be a strong intraday price rejection point. One can also notice the candle is over 50% of the entire candle’s size suggesting its strength. One other key point in the price action is that there is two way interest here as the support of this candle lies with a decent rejection to the downside which is also at a pivot.

Thus, when rejections occur at intraday pivot levels, they have more potency so look for them to line up at a pivot whenever possible.

2) Fibonacci Levels – another tool to look for and help confirm the rejection is for them to occur at key Fibonacci levels. Which ones would we consider key? The 38.2 / 50 / 61.8% fib levels. Now which fib levels are the next question because they can be drawn from anywhere. Anytime you have a strong trend in place, there will be market swings and corrections. Fibs were meant to be used during trends to find retracement levels where pairs would find support/resistance in their current trend to continue the trend. Thus, when we pull fibs, we always pull them in the direction of the trend looking at the major swings. Below is an example.

In this chart above we have the GBPUSD 4hr chart where price was consolidating after a downmove and then started another leg down. Price hit a floor around 1.5900 and then started to attempt a reversal. However it created two rejection wicks right at the same level which was not only support for the previous consolidation move but also a 38.2% fib level thus making it a good rejection area according to Fibonacci price levels.

By combing previous support/resistance levels along with a key Fibonacci level, when a rejection wick occurs at these levels, it gives it further confirmation of it being a legitimate rejection.

3) Key Support/Resistance Levels – previous swing highs and lows are great places to look for rejections to take place because the market had already rejected price there once before. If the market rejected price at a key level once before, it certainly should be considered it could happen again.

Looking at the chart below, we actually have two examples in the same chart. Starting at the bottom the price action was stable and holding at a particular level building a base around the 146.00 handle. After several touches on this price level, it launched up towards 150.68 where it rejected back down to 149.00 or 268 pips. It then very quickly re-advanced on this same price and swing high only to create a very strong rejection at this level by producing a very large wick. The price action from here then went all the way down to where? The last major base of support down at 146.00. Thus, by spotting these previous key swing highs and lows, and looking for larger rejections off of them, we can find great trading opportunities or examine the price action to confirm our reversal trade.

To learn more about how to spot these simple high-probability setups, you can check out the Advanced Price Action or the ProForex Course which will teach you rule-based proprietary systems to trade these profitable setups.

Trading Kumo Breaks

Traditionally, the Ichimoku Cloud is known for its ability to pick up trends and keep traders in them until they are over. It should be noted that any system or method which is good at finding trends is also good at finding reversals because if you are finding the times/locations when trends are ending, then you are finding consequently a reversal.

There are several components inside the Ichimoku Cloud which give it a unique capacity to find trends, establish if we are in a trend, which direction and when it is over. One of them is the Kumo or Cloud which is one of the most unique technical indicators out there.

Kumo Composition
There are two main lines of the Kumo which are referred to as Senkou Span A and Senkou Span B.  For the purposes of efficiency, we will refer to them as Span A and Span B.  The space or value in between these two lines is what forms the Kumo.

Span A is formed by taking the Tenkan Line and adding it to the Kijun Line (white and red lines respectively from chart above), then dividing that value by 2 and plotting it 26 periods ahead.  The formula is;

(Tenkan Line + Kijun Line) / 2 placed 26 periods ahead

Span B is formed by taking the highest high (over the last 52 periods), adding to it the lowest low (over the last 52 periods), dividing that by 2 and plotting that 26 time periods ahead.  The formula is;

(Highest High + Lowest Low for the last 52 periods) / 2 and plotted 26 time periods ahead.

What is it used for?

The most important way to look at the Kumo is as support and resistance - meaning if it is thick, then the support/resistance (depending upon where price is in relationship to the cloud) is strong.  If price is above the Kumo, we are in a general uptrend or would want to look for more buying opportunities.  If price is below the cloud, it is below resistance (the Kumo) and we want to be searching for more shorts than longs.  The longer price stays below/above the cloud, the stronger the trend we are in and the more support/resistance the Kumo will offer.

These are generic ways to look at it but effective. What is important to note is in trends, price will stay on one side of the Kumo. The farther price is from it, the stronger the trend and more volatile it is. Thus, the Kumo can be a very effective tool for option traders as well as trend/momentum traders.

How can we use it for Reversals?

Because the Kumo will often hold price on one side of it, when price breaks it, such a move can often signal a reversal. There are various factors which will increase the likelihood of a reversal such as:

Thickness of the kumo when broken

How long price has been on one side of it

How far price has moved before touching/piercing the kumo

What time frame you are working on

Etc.

These are all critical when assessing whether a Kumo break is signifying a reversal or not.

A few examples
Take a look a the AUDUSD below. It was below the Kumo for a long period of time and had a massive fall. Then after a couple of attempts on the daily chart, broke above the Kumo. Now remember the Kumo represents support and resistance so the pair breaking above it, then coming back to the Kumo to treat it as support was a great role-reversal play. After retouching the Kumo, it went on a 3000 pip run!

Another example is on the AUDJPY on the daily chart which was on a smooth consistent uptrend. Look what happened when it broke the kumo. It took a few days, but then after attempting to break back above, treated the Kumo as resistance, and the pair then fell over 1300 pips in a few months.

Final Notes
The Kumo Break method is one of the key systems used by Ichimoku traders for spotting key reversals, qualifying them and giving traders a unique opportunity to either take profits or reverse positions. Its great for timing trends, reversals and trading key reversals when they are in play. Because of its unique ability to measure support and resistance, the Ichimoku Cloud and its Kumo construction offer the trader some unique trade opportunities.

It should be noted there are other key elements needed to trade the Kumo Breaks with precision. We have analyzed Kumo breaks on Forex, Futures, Commodities and Indices over the last 10 years and with our proprietary indicators and analytical programs, are able to give precise measurements for how far and long a Kumo break should travel which gives you a precision edge when trading them.

To learn more about our proprietary Ichimoku systems, visit our Advanced Ichimoku Course where you will get access to 10 years of proprietary quantitative data on how to trade Ichimoku Clouds.

Trading the Tenkan/Kijun Cross

This is by far the most popular of the trading methods in the Ichimoku Cloud’s arsenal.
It is simple, elegant and great at picking up trends and trend reversals. If you like trading trends or momentum trading, the Tenkan/Kijun cross is a great method to use.

What are they?
The Tenkan Line or Tenkan Sen (Sen means line in Japanese) is known as the conversion line or turning line is similar to a 9SMA but actually is quite different.  Remember a SMA (simple moving average) will smooth out all the data and make it equal but the Tenkan Line will take the highest high and lowest low over the last 9 periods.  The explanation for this is Hosada felt price action and its extremes were more important than smoothing any data because price action represented where buyers/sellers entered and directed the market, thus being more important than averaging or smoothing the data out.  As you can see by the chart below, the Tenkan Line is quite different than a 9SMA.  Because the TL (Tenkan Line) uses price instead of an averaging or the closing prices, it mirrors price better and is more representative of it.  You can see this when the TL flattens in small portions to move with price and its moments of ranging.

Akin to all moving averages, the angle of the Tenkan line is very important as the sharper the angle, the stronger the trend while the flatter the Tenkan, the flatter or lesser the momentum of the move is.  However, it is important to not use the Tenkan line as a gauge of the trend but more so the momentum of the move.  However, it can act as the first line of defense in a trend and a breaking of it in the opposite direction of the move can often be a sign of the defenses weakening.

The Kijun Line (or Kijun Sen) is known as the datum line, standard line or trend line designed to indicate the overall trend for the instrument or pair.  The formula behind it is the same as the Tenkan line using price action and the highest high + lowest low with the only change being in the periods as it does it over the last 26 periods.

Why 26 periods?  The answer to that is a matter of history.  When the Ichimoku was first created, the Japanese markets were open 6 days a week on Saturdays.  If the markets are open 6 days a week, this generally results in 26 trading days for the month - hence 26 periods for the Kijun.  In essence, what it was meant to be was a measure of the highest high + lowest low for the last month of price action.  If the Kijun has been climbing - it means price has been gaining ground for the last month.  If it is flat, then it will be the midpoint of the range of price for the last month of price action (or representative of the price equilibrium).

Also like the Tenkan Line, the angle of the Kijun is reflective of the overall trend in place.  Price breaking the Kijun after being in an up/down trend often has serious consequences for that trend and can many times lead to a reversal of sorts.  Ultimately because it uses a longer period to measure price action, its a more stable method for determining the direction of the trend than the Tenkan Line.  Because of price to respect this line during a strong trend, it can potentially be used as a stop loss for traders already in the correct direction of the trend.  Hence, when price breaks or closes below it by a significant amount, the trend is often over.

Applications for the Tenkan and Kijun

The most common usage of the Tenkan and Kijun are the ‘cross’ or what we call the TKx (Tenkan-Kijun Cross).  Similar to how a MACD uses a cross of its two lines, the Ichimoku Cloud does the same.  It is interesting to note that the Ichimoku uses the same periods as the MACD, however it was created over a decade earlier.

One of the main signals for Ichimoku traders, the TKx can often indicate when a trend is about to begin by forming a cross (upward cross = possible upward trend while downward cross = possible down trend).  A generic upward cross can be used as a bullish signal (or exit for people already short) and a generic downward cross can be used as a generic bearish signal (and vice versa for current bulls).  However, notice we used the term ‘generic’ meaning there is more to the cross.

Hosada was able to give a further definition to the cross based upon its position to the Kumo or cloud.  If the cross was below the Kumo, then it was considered a ‘weak’ signal since the cross was below the Kumo or below resistance.  A medium signal was when a cross happened inside the Kumo as it was occurring within the field of support/resistance.  A strong signal was when the bullish cross happened above the Kumo as it was happening after clearing resistance.  The opposite is true for bearish signals whereby a weak signal is a cross above the Kumo, while a medium signal is inside the Kumo and a strong signal below the Kumo.  One important reminder to all this is to make sure you reference the Chikou Span to see how current price is in relationship to previous price action.

Exhibit A

Take a look at how the USD/INX gave 3 strong downward crosses with each move selling off nicely and never penetrating the Kumo highlighting the downtrend.

In another example, the AUDUSD gives a nice upward cross in an already established uptrend. First it entered the Kumo but had a very shallow penetration leading to a strong upmove over 1300pips from the Tenkan/Kijun cross.

Closing
There are many important factors to consider when trading the Tenkan/Kijun cross such as time frame, kumo shape/configuration, previous moves-series of crosses, angle/shape of the cross, etc.

We have proprietary quantitative data on all pairs for the last 10 years to give you an edge when trading the Tenkan/Kijun cross. To get access to this data, or learn how to trade the Ichimoku on an advanced level, check out the Advanced Ichimoku Course.