Ichimoku Cloud Trading Strategy: Rules & Backtest

The Ichimoku trading strategy uses a technical analysis indicator that defines support and resistance levels, shows the trend direction, and gauges the momentum of the trend. It does this by plotting multiple averages on the price chart, which forms a ‘cloud’ that indicates where the price may find support or resistance in the future.

Technical indicators are used by most traders in the financial markets. One of the challenges faced when using most indicators is the issue of false signals, which is what the Ichimoku Kinko Hyo tries to solve. But what is the indicator made of? What is an Ichimoku trading strategy?

In this post, we look at the Ichimoku indicator and end the article by backtesting an advanced Ichimoku trading strategy.

Key takeaways:

  • The Ichimoku Cloud is a technical analysis indicator that defines support and resistance levels, gauges momentum, and provides trading signals.
  • Backtests reveal that the Ichimoku strategy does a good job of reducing drawdowns.
  • Ichimoku works on most assets, but it mostly fails to beat buy and hold.

What is the Ichimoku cloud indicator?

The Ichimoku Cloud is a technical analysis indicator that defines support and resistance levels, gauges momentum, and provides trading signals. It does this by plotting multiple averages on a chart. Some of the averages form a “cloud” that attempts to forecast where the price may find support or resistance in the future.

In Japanese, the full name of the indicator is the ‘Ichimoku Kinko Hyo’, which roughly means ‘one look equilibrium chart’ — because, with just one look, traders can receive a range of information.

The indicator was presumably developed in 1968, although we have seen posts it was developed as early as the 1930s. Although most of the technical indicators are created by mathematicians or statisticians, the Ichimoku was created by Goichi Hosoda, a Tokyo-based newspaper writer alongside assistants who were doing the actual math behind it. The indicator is employed by several Japanese traders and some western traders because it offers many confirmations of price actions that filter for higher probability trades.

At first glance, the Ichimoku can be intimidating because of the numerous lines drawn on the chart. However, a quick breakdown of each component makes it a more commonly accepted tool. Here are the components:

  1. Kijun Sen (Blue Line). The Kijun sen or the standard line is plotted by calculating the average of the highest high and lowest low of the past for the last 26 periods.
  2. Tenkan Sen (Red Line). The Tenkan sen is plotted by calculating the average of the highest high and lowest low for the last 9 periods. Both the Kijun and T