The Ichimoku Kinko Hyo Trading Strategy That Actually Works

The Ichimoku Kinko Hyo, or better known as the Ichimoku Cloud indicator, often seems like the legendary sword of a samurai warrior — a coveted, enigmatic tool that promises to reveal the secrets of the market with a single glance. 

Like a well-guarded treasure, there are thousands of manuals scattered across the digital realm, each adorned with beautifully illustrated strategies, tempting traders with visions of financial glory. “Step right up, and witness the miraculous Ichimoku Cloud — a path to untold riches!” – they say. Yet, as wise traders know, in the world of finance, not everything glittering is gold.

We’re not just going to take their word for it. In the spirit of a true samurai who doesn’t believe in myths until he tests them himself, we’re diving into the world of backtesting. We’re going to slice through the hype with the katana of analysis to uncover the truth about the Ichimoku Cloud, especially in its alliance with the RSI (Relative Strength Index). It’s a duo that’s often spoken of in hushed, reverent tones, but does it really live up to the legend?

What Kind of Strategies Does Ichimoku Indicator Suit Best? 

But why the Ichimoku Cloud, you may ask? We have already ventured into the world of moving averages and tested Double Bollinger Bands strategy in our previous explorations, mastering the art of trend-trading and navigating the tricky waters of ranging markets. Now, we turn our gaze to a new horizon — identifying trend reversals and seizing opportunities at the cusp of change.

Continuing our journey with the Ichimoku Cloud, it’s important to note that while this indicator has multiple applications, we’re honing in on a specific aspect for our analysis. The reason? Precision. By focusing on a particular approach, we aim to extract more nuanced and valuable insights from our backtesting.

In this phase of our exploration, we’ll be scrutinizing a popular breakout strategy using the Ichimoku Kinko Hyo. This is not to say it’s the only way to wield this powerful tool, but it’s a path ripe with potential. As we delve into this strategy, we remain open to the idea of fine-tuning it. Think of it as a bonsai tree, where careful pruning and shaping can reveal a more compelling and effective form.

To check Ichimoku Kinko Hyo trading strategy’s performance you can:

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How to interpret Ichimoku Kinko Hyo signals? 

Venturing further into our exploration, let’s demystify the basics of the Ichimoku Kinko Hyo. This indicator is not just a single line or a simple moving average; it’s a complex tapestry woven with multiple components, each offering unique insights into the market’s movements. Imagine it as a sophisticated dashboard that provides a holistic view of market trends and momentum at a glance.

• Kumo (Cloud): The heart of the Ichimoku system, the Kumo, or cloud, is formed by two lines, the Senkou Span A and Senkou Span B. These spans project areas of future support or resistance. When prices are above the cloud, it’s generally a bullish signal, and when below, bearish. The cloud’s color also changes, providing a visual cue of market sentiment. A green cloud suggests bullish trends, while a red cloud indicates bearish trends.
• Tenkan-Sen (Conversion Line): This line represents the short-term market trend and is calculated as the average of the highest high and lowest low over the last nine periods. It’s quicker to react than a simple moving average, making it a handy tool for spotting minor trend reversals or momentum shifts.
• Kijun-Sen (Base Line): Serving as a marker for medium-term trends, the Kijun-Sen is derived from the average of the highest high and lowest low over the past 26 periods. It often acts as a significant level of support or resistance and can be a signal for trend continuations or reversals.
• Chikou Span (Lagging Span): This line is the current closing price plotted 26 periods back. It helps validate signals given by other lines, especially when it crosses the price line. If the Chikou Span is above the price, it could indicate bullish momentum, and if below, bearish momentum.

By interpreting these elements collectively, traders can glean a comprehensive view of the market. The Ichimoku Cloud doesn’t just tell us where the price is or has been; it provides a dynamic projection of where it might find support or resistance in the future. This forward-looking feature is what sets it apart from many other technical indicators, making it a favorite among traders who wish to stay a step ahead in the ever-changing dance of the markets.

The Start of Backtesting Ichimoku Strategy. The First Iteration. 

With a respectful bow to the land that gave us the Ichimoku Kinko Hyo, we chose the GBPJPY currency pair as our dojo for backtesting. The 4-hour chart is our battleground, the default settings of Ichimoku our strategy parameters, unaltered like the recipe for an ancient matcha tea ceremony.

The Rules of Engagement:

For a Buy signal:

• Cloud Piercing: We await the price to decisively break above the Ichimoku Cloud, with a candle closing above it—this is our initial battle cry.
• Red over Blue: The confirmation comes when the conversion line (red) ascends above the base line (blue), akin to the red disc of the Japanese flag rising over the horizon.
• Retreat Below Base: The strategy dictates a tactical withdrawal once the price candle closes beneath the base line, regardless of whether we’re in the land of profit or not.

For a Sell signal:

• Cloud Descent: We watch for the price to dive below the Ichimoku Cloud, with a candle closing below as if it’s a samurai making a stealthy nocturnal escape.
• Red under Blue: Our confirmation is the conversion line (red) sneaking below the base line (blue) like a whisper of a shadow in the moonlight.
• Advance Above Base: We exit our position once the price candle closes above the base line, whether we’ve secured a bounty or not.

With our strategy set, we embarked on the path of the warrior, seeking to validate the prowess of this ancient indicator in modern markets. The humor and light-heartedness of our journey do not undermine the gravity with which we undertake this mission. As we proceed, we might find that our strategy needs refinement — perhaps a tweak of the time frame or an additional filter for our entries and exits. Or maybe, like a haiku, its simplicity is where its beauty and effectiveness lie.

In the spirit of Bushido, we pursue not just gains but the way of the strategy, the discipline of backtesting, and the wisdom that comes with it.

Examining the Results: The First Descent Through the Clouds

As we unfurl the tapestry of our Ichimoku Cloud backtesting journey, we find ourselves peering over the edge of a rather steep cliff. The number crunching has spoken: a loss of $5,074, leaving our trading armor feeling a tad lighter. This outcome, akin to a samurai discovering his sword is actually made of bamboo, is, to put it mildly, quite disappointing.

Despite the balance of average wins to losses sitting comfortably in what one might consider a “safe zone” with a risk-to-reward ratio hovering near 1:1.5 ($1,053 vs $1,473), it’s the outliers that have us raising an eyebrow. A solitary victorious trade netting $5,721 and a most ungenerous single loss of $3,519 have us questioning the loyalty of this strategy.

These rogue waves in our sea of data further erode our confidence, especially when considering the slim total of 24 trades over a year-long campaign.

Observations from the Front Lines:

• The Outlier Effect: With such erratic swings, these outliers have the power to flip our statistics on their head with just one more trade, profitable or not. It’s like relying on a fortune cookie for investment advice — one that could just as easily predict a windfall as a downfall.
• The Confirmation Conundrum: Our so-called confirmation signal, rather than being the trusty sidekick we hoped for, turned out to be more of a mischievous fox spirit. We found ourselves waving goodbye to several profitable trades that slipped through our fingers, suggesting this filter might not be the ally we thought it was.
• The Promise of the Cloud Breach: One silver lining (or should we say, cloud lining?) is the initial breach of the Ichimoku Cloud. This signal appeared to be a reliable herald of a trend ready to don a new kimono, indicating a potential trend reversal.

What’s the takeaway from this episode of our market saga? It seems we need a more cunning exit strategy, one that allows us to bow out gracefully from trades, retaining our honor and hopefully, some profits too. There lies the possibility that somewhere in the shadows, a more efficient method is waiting to be discovered, one that will allow us to harness the full power of the Ichimoku Cloud without getting caught in the rain.

As we contemplate our next moves, we must remember the old adage: “Even monkeys fall from trees.” Even the best strategies can falter, but with each misstep, we learn, adapt, and become more adept in the art of trading. Let’s sharpen our blades for the next iteration.

The Second Iteration of Backtesting: Hosting RSI 

In the grand narrative of our backtesting odyssey, we’ve arrived at a new chapter, where we invite the RSI (Relative Strength Index) to the strategy table, hoping it will play the role of the wise sensei to our eager Ichimoku apprentice.

Rules Reforged for Ichimoku Strategy

• The Timeframe Transition: We switch our gaze from the 4-hour horizon to the bustling streets of the 1-hour chart. Here, the market’s heartbeat is quicker, allowing us more opportunities to draw our trading sword with the intention of gathering a larger sample size, thereby hoping to bolster the reliability of our statistics.
• The Stop Loss Strategy: With a pinch of superstition and a nod to cultural nuances, we set our stop loss at 400 points. In Japanese culture, the number 4, or ‘shi’, shares pronunciation with the word for death. So why not stop the life of unsuccessful trades at this point? 
• The Confirmation Bypass: The conversion line’s position will no longer be our gatekeeper. Instead, we shall enter the trade based on the cloud breakout alone, forgoing additional confirmation like a warrior trusting his instincts.
• The RSI Profit-Taking Pivot: We aim to grab profits when the RSI ascends into the overbought realm above 70 for long trades or dips below 30 for shorts. These thresholds will be our signposts, guiding us on when to pocket our gains. However, should the RSI already dwell beyond these realms at the time of an Ichimoku signal, we shall bypass the signal, avoiding potential traps.
• The Lucky Number Eight: The RSI period is set to 8, an homage to Japanese culture where it symbolizes wealth and prosperity—may it bring abundance to our trades.
• The Art of Reversal: Should the winds change and we receive a signal opposite to our current position, we’ll perform a swift about-face, reversing our trade to align with the new direction.

These changes aren’t just whimsical. They’re our way of folding in layers of strategy, much like a blacksmith forging a katana, hoping that each fold will bring strength and resilience to the blade. We venture into this with a blend of educated guesses and respect for the rich culture from which the Ichimoku indicator originates.

Reflections on the Second Iteration of Backtesting Ichimoku Strategy

The second iteration of our backtesting journey, with the RSI as our navigator, has brought us to a more prosperous port. The numbers tell a tale of uplifted spirits: a net profit of $8,900.46, with 85 trades over the course of the year.

39 of these were profitable trades, an encouraging sign that our strategy may be aligning with the mysterious rhythms of the market. Yet, our trading sense tingles with the notion that our profits could flow more freely.

The Next Step. Third Iteration of Backtesting Ichimoku Strategy

As our backtesting tale unfolds, we find ourselves at a pivotal juncture, sharpening our tools and refining our tactics. Our previous forays have equipped us with valuable insights, and now we stand poised to adjust our grip, ready to double our efforts. Literally. It’s time to explore a strategy that wields not one, but two proverbial swords in the dojo of the market.

Strategizing for the Next Wave:

• Doubling: We’re considering doubling the lot size. It’s like sending in two ninjas instead of one. If the first one completes the mission at the RSI threshold of 70 or 30, we swiftly move the second to safety at break-even.
• Profit Maximization Maneuver: The second lot, now at less risk, awaits its moment of glory. If the RSI hits the heady heights of 90 or the depths of 10, we’ll take our profits, a bit like catching a falling star in the palm of our hand.
• Staying Agile: True to the way of the samurai, we remain ready to reverse our position with each new signal. Like a skilled warrior adapting to his opponent’s moves, we switch stance with each breach of the Ichimoku Cloud.
• The Dance of Entry and Exit: There will be moments of delicate balance, where the closing of the second lot and a new entry won’t align — specifically if the RSI is above 70 or below 30 at such times. In these instances, patience becomes our virtue, as we wait for the next clear call to action.

The Final Chronicle: Unveiling a Strategy in Bloom

As we unfurl the scroll to reveal the final act of our backtesting drama, the numbers gleam back at us, a testament to the evolving art of our strategy. With a net profit of $23,179.51, our trading journey has brought forth a garden of gains that could make even the most stoic samurai crack a smile.

The strategic milestone is as clear as the full moon on a crisp Kyoto night: even as we ventured boldly, doubling our lot size, the shadow of risk did not stretch significantly further than before, with the drawdown in this third act (a manageable $6,793) only slightly upstaging that of the second ($5,249). It’s as if our trading katana has been sharpened to slice more deeply, yet without the blade growing brittle.

Yet, as any master of strategy knows, the quest for improvement is as endless as the horizon. Our current setup, while effective, is not the final brushstroke on this canvas. The Ichimoku settings whisper of untapped potential, the RSI levels beckon for a fine-tuner’s touch, and the fixed stop loss we’ve employed awaits scrutiny.

Adjust, experiment, and refine. There is a tapestry of data waiting for your interpretative eye, a wealth of charts yearning for your unique strategy. May your journey through the markets be as enlightening as it is profitable.

FAQ

What is Ichimoku Kinko Hyo?

Ichimoku is a Japanese charting technique developed before World War II by a Tokyo newspaper writer, which literally means “one look”, presenting a panoramic view of the market.

It is enjoying renewed popularity and a chart of this style is referred to as Ichimoku Kinkou Hyou — the table of equilibrium prices at a glance.

An Ichimoku chart is a trend-following system with an indicator similar to moving averages.

What are the main elements of the Ichimoku Kinko Hyo system?

1. Tenkan Sen 

The first indicator is the Tenkan Sen, representing the short-term price movement.

Its formula is: (Highest High plus Lowest Low)/2 for 9 periods.

2. Kijun Sen

It represents the medium-term price movement. The formula for the Kijun Sen is: (Highest High plus Lowest Low)/2 for 26 periods

The Kijun Sen is analogous to the 30-period simple moving average used by most traders.

3. Chikou Span

It is described as the momentum of price, and it tells us if a trend can occur. We should keep in mind, a trend is where price continues moving in the same direction for a prolonged period of time.

The formula for the Chikou Span is: Current Price moved back 26 bars.

4. Kumo Cloud components

The 2 components of Kumo Cloud are the Senkou Span A and Senkou Span B.

Together, they provide a lot of market information that comes in the form of the open space between them. The gap or space, between the Senkou Span A and Senkou Span B, is known as the “Kumo Cloud.”

lf the Senkou A is greater than Senkou B then the cloud is considered to be bullish and if Senkou A is less than Senkou B then it is bearish.

These four elements together tell the entire story behind the chart, and the key for the trader is to understand each component individually and how they work together.

How can clouds be used as a trading roadmap?

The most important aspect of cloud charts is that the offer rigorous definition of the trend direction that one can get at a glance.

We can know immediately whether we are in uptrend or downtrend and adjust our decision-making accordingly.

Even if one doesn’t use the trading signals and rely on other techniques, the cloud still tells us whether we should be long in an uptrend or short in a downtrend.

The way clouds are constructed that shifts the cloud forward and the lagging line back offers a better view of the crossover point after a high or a low.