By Matthew Rodrigues
When you start investing, you may think you don’t need a strategy. You may be fine in the beginning, you may even make good profits on your trades. Because of this, you decide it's time to up the ante to maximize your returns, and you start trading over 50% of your portfolio. But then you hit a hiccup, some bad news came in the form of a decreased earnings report at the end of the quarter. Now you have your portfolio’s value has already dropped 15% within an hour of the market opening, while it continues to decline quickly. “Trading without a strategy is ok.......if you know what you are doing,” Warren Buffet. The hard part is knowing what you are doing, as a beginner. That’s where strategies come into play, which can greatly help beginners. What will be discussed in this article will be the Ichimoku cloud, a beginner-friendly strategy that anyone can deploy.
Some terms to know
Resistance - when the demand outweighs the supply
Support - when the supply outweighs the demand
Momentum - the trend/direction the stock is going
What is the Ichimoku Cloud?
The Ichimoku cloud is a collection of pattern-based signals based on the price of the stock due to fluctuations of resistance and support as well as trends accelerating its momentum. The Ichimoku chart then takes all of these “parameters”, finds averages, and plots averages onto a chart. This chart will try to predict whether the stock’s price will go up or down in the future.
How to make it:
To start, you take the period highs and period lows over any given period in time of the stock and have to calculate the rest using formulas. This article about Ichimoku Clouds on Investopedia has the formulas you would need to calculate averages to make the Ichimoku cloud. The formula in their article is set to calculate for a nine-day period, so adjust the period as necessary. Once you have the components: the conversion line, baseline, leading span A, leading span B, and the lagging span(which isn’t really calculated), you can make the Ichimoku cloud. Once you have calculated all of the components, plot both leading span A and leading span B 26 periods into the future. Plot the lagging span (where the stock closed 26 periods ago) behind the latest closing period of the stock. There usually will be a difference between leading span A and leading span B which will be colored depending on the position of the spans. If spam A is above span B, color the space in between the lines, which makes a cloud-like appearance, green. When span A is below span B color the cloud red. Each of these steps creates only one data point, so the process will have to be repeated many times to make a full cloud. Using excel or some sort of spreadsheeting software is highly advisable for this. Or a pre-existing software that makes the Ichimoku cloud for you can be used as well, such as this free one here.
How to interpret the cloud:
After the work put into making this chart, it is nice to know that it is relatively easy to interpret the chart quickly. The word Ichimoku roughly translates into one look. This is the way the chart was designed to be interpreted. When leading span A is above leading span B, this indicates an uptrend as the cloud will be colored green. When leading span A is below leading span B, this indicates a downtrend as the cloud will usually be colored red. The strength of the Ichimoku cloud is that it indicates whether there will be an increase or decrease of support or resistance in the future, whereas other charts indicate fluctuations of support and resistance in the present.
Potential Issues:
The Ichimoku cloud has many components that go into it, as seen when calculating them for every single data point. This can be distracting or make the graph somewhat difficult to interpret. To remedy this, the only lines shown on the chart are leading span A and leading span B, when typically looking at the chart. The cloud is also based only on historical data, which is only what has already happened, not accounting for potential random events or the release of a financial statement, which can happen to greatly increase or decrease value. Because of these shortcomings, advanced investors prefer to use the Ichimoku cloud in conjunction with other strategies as well.
Conclusion:
The Ichimoku Cloud is an effective trading strategy to track the trajectory of an asset based on fluctuations in support, resistance, and momentum. Its chart is the plotting of components: the conversion line, baseline, leading span A, leading span B, and the lagging span. It can be used by itself but is better when combined with other strategies.