CHARTING
How Clouds Can Obfuscate, Yet Reveal Ichimoku Kinko Hyo Charts
by Nicole Elliott
Here's another charting method that's been around for decades, and yet can be brand-new to most Western audiences.Ichimoku kinko hyo is a method of technical analysis that has been around since before World War II, yet is virtually brand-new to most Western audiences. Why? Because textbooks on the subject have been, until recently, available only in Japanese.
I joined Mizuho Bank as a senior analyst 10 years ago. When I arrived, I realized much to my horror that all the Japanese dealers I would be working with were well up to speed with charts, and they used an incredibly complex method that I hadn't a clue about. These charts looked like a writhing mass of multicolored, tangled spaghetti! But curiosity got the better of me. Risking the loss of face and career prospects, I approached the Japanese dealer who spoke the clearest English and asked him to explain. "Oh, these? They are cloud charts," he said, "and we use them all the time." And as I found out, Japanese dealers really do, and if you are trading anything yen-related I urge you not to ignore them.
THE BUILDING BLOCKS
The key concept behind the ichimoku method is that price and time are inextricably linked. Via laborious backtesting (by hand!), newspaper writer Goichi Hosoda (who used the pseudonym Ichimoku Sanjin) came up with four useful moving average-type lines before World War II, finally publishing a book on the subject in 1968. The lines are displaced forward and backward around the basic building block, which are daily candlesticks. These are used just as conventional bar charts: plotting trends, looking for patterns, areas of support and resistance, reversals, and so on.
The first two lines to be plotted are the nine- and 26-day moving averages. Do not use closing prices to calculate these. Instead, use the day's midpoint (high plus low divided by two). When the shorter one is above the longer one, the trend is toward higher prices, and vice versa in a bear market, with the nine-day moving average plotted under the 26-day. So far, it's easy. The number of days used, while optimized through extensive backtesting (without the help of even a calculator), is interesting. The 26-day reference is cultural; in addition to the five-day workweek, the Japanese financial markets previously were open on Saturday mornings but are no longer, so there are 26 working days in an average month for the technique.
The next line to plot is known as "leading" or senkou span A. It is the sum of the two averages, divided by two, plotted 26 days ahead of the last complete day's trading. Leading/senkou span B is calculated by taking the highest price of the last 52 days (double 26), adding the lowest price over that period, and again dividing by two -- same name but very different construction. The space between these two lines is shaded (in any color you choose) and forms the "cloud."
The fifth and final line is chikou span (also known as the "lagging span"). It is the most recent closing price plotted 26 days ago. Note that the use of the English word "span" is deliberate. It denotes a certain length of time, which as mentioned is central to the method.
...Continued in the September issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the September 2007 issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2007, Technical Analysis, Inc.
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