Swing Trading With Ichimoku Clouds (AAL)

Japanese journalist Goichi Hosoda developed Ichimoku Kinko Hyo, also known as Ichimoku Clouds, in the 1930s and worked with the trading tool for more than 30 years, before offering his system to the public in a 1968 book. It became a popular technical indicator in Asia in the 1970s and 1980s but wasn’t used extensively in the Western world until the start of the twenty-first century, due to the lack of comprehensive English translations. It has grown enormously popular on this side of the world in the last 15 years, with traders drawn to its versatility as a one-glance trend direction and support/resistance signal generator.

Ichimoku Clouds are composed of five lines that interact to create a visual reference system. Calculations for four of the lines start with the highest high and lowest low over the last two sessions, which are then manipulated by variable period length, and time shifting backwards or forward by 26 periods. The current closing price, time-shifted backwards by 26 periods, generates the fifth line. When displayed together on the price chart, they give the appearance of rising or falling clouds, with price and signal lines interacting at key intersections.  

The five lines are designed to work together in creating a visual analysis tool that supports trading decisions. The cloud or Kumo marks the trend direction, with traders seeking long exposure when price is trending above the cloud and short exposure when below the cloud. Cloud direction adds to trend intensity, with an uptrend showing greater strength when the cloud is rising and a downtrend showing greater weakness when the cloud is falling. Price crossing through the cloud triggers a trend reversal signal, while pullbacks can be used for trade entries that look for the cloud to provide support or resistance .

The Tenkan Span (Conversion Line) and Kijun Span (Base Line) denote moving averages that issue additional sets of buy and sell triggers when they cross over or touch and reverse. These lines work as intermediate entry and exit signals within an established uptrend or downtrend. Price crossing the lines generates a final set of momentum-based signals, with crosses above the lines in uptrends or below the lines in downtrends pointing to increased momentum that supports new entries or adding to existing positions.

The Chikou Span (Lagging Span) plots a mirror image of the price pattern shifted backward by 26 periods and is designed to offer a quick snapshot of the last month of price action. The line also serves as an instant trend recognition signal, bullish when placed above current price action and bearish when placed below. The distance between the line and price measures current momentum, with a broad separation pointing to high trend momentum while crossovers or narrow separation point to low or non-existent trend momentum.

Looking at the American Airlines (AAL) example, price drops to a 10-month low in October and turns higher, issuing a buy signal when it rises above the cloud in a new uptrend (A). The cloud doesn’t turn higher into a new uptrend until December (B) when the stock price had already risen more than 20 points off the corrective low. A December consolidation finds support on top of the Tenkan Span (Conversion Line), issuing an intermediate buy signal that allowed trend followers to open new trades or add to existing positions (C). Finally, note now the Tenkan Span crossed over the Kijun Span to the upside right after the October low (D), offering a high risk long-side entry for aggressive swing traders.

Ichimoku Clouds offer surprisingly complex market analysis in a single visual image that addresses price, trend and momentum. The technical indicator works equally well in both directions and in all time frames, making it a powerful tool for active swing traders.