Combining the 20 EMA with the Ichimoku cloud

In our price action studies we have focused on trend indicators with the EMA 20 being a key feature in majority of the discussions. This in combination with various price action signals has offered excellent trade entries with impressive risk: reward ratios.

In this article we will introduce yet another powerful trend indicator, the Ichimoku cloud. The Ichimoku Cloud, also known as Ichimoku Kinko Hyo, is a versatile indicator that defines support and resistance and identifies trend direction. However we will only use two out of the five elements of this indicator:

Senkou Span A (Leading Span A): (Conversion Line + Base Line)/2))

This is the midpoint between the Conversion Line and the Base Line. The Leading Span A forms one of the two Cloud boundaries. It is referred to as “Leading” because it is plotted 26 periods in the future and forms the faster Cloud boundary.

Senkou Span B (Leading Span B): (52-period high + 52-period low)/2))

On the daily chart, this line is the midpoint of the 52 day high-low range, which is a little less than 3 months. The default calculation setting is 52 periods, but can be adjusted. This value is plotted 26 periods in the future and forms the slower Cloud boundary.

Combining the EMA 20, a lagging indicator, and the Ichimoku cloud, a leading indicator, can augment trend trading.

Let us look at a couple of ways in which the two can be combined:

A: Filtering out low quality Price Action Signals

 

PIC1

In this chart of the EURUSD daily time frame, we can see that a bearsh price action signal occurring below a bullish cloud only yield about 50% of the pips in comparison to a bearish signal that occurs under a bearish cloud. This means a prudent trader would want to decrease his profit target levels for similar setups and increase the targets where the bearish signals occur below a bearish cloud.

B. Trade Targets

 

 PIC 2

In the past we have used Fib levels, pivots and previous S/R levels as trade targets. Notably the Ichimoku cloud can also act as a target. The Senkou Span A and Senkou Span B act as future dynamic support and resistance levels

In the above example, a bearish pinbar occurred on the EMA 20 just above a bullish cloud. A trade entry and impulsive break to the downside followed for the next 5days. Price is then supported off the Senkou Span B and a bullish run follows. Using this lower end of the cloud in this instance could have enabled a trader harvest the maximum number of pips from the move.

Furthermore it is evident that price action signal off the EMA 20 while price is above a bullish cloud is an even better way to filter out high quality price action signals. The same applies to bearish signals below a bullish cloud.

 PIC 3

We can therefore conclude that combining the Ichimoku cloud with the EMA 20 makes it easier to; filter out the quality of trade setups as well as offer realistic profit targets for trades taken when then two indicators are involved.

Ichimoku Technique Signs

The Ichimoku Kinko Hyo technique offers the chance to obtain many different types of operating signals through the use of a single graph. As for all trading techniques, when we are using the Ichimoku Kinko Hyo for our operations, it is always advisable to take into account other elements (volumes, sentiment, seasonality, oscillators, etc …), but certainly the immediate graphic  understanding of the trend and its evolution represent the strongest point of the Ichimoku technique.

As this technique aims to find the best point of entry within a trend, the answers we get from the signals will obviously be probabilistic and will have to conceive a margin of error. A wise money management will curb this phenomenon.
Here below, we will study in deep the 5 trading techniques that can be used by any trader. As we will see below, all the examples have been classified according to the emerged signal strength: strong, neutral and weak. The element that distinguishes the strength of the signal is where the signal is placed respect the Kumo, but in some cases there can be other indicators that can help the trader in the interpretation.
TENKAN SEN /KIJUN SEN CROSS
This trading signal is applied when the Tenkan Sen (black line) cuts the Kijun Sen (red line)upward or downward.
The generated signal is bullish when the Tenkan Sen cuts the Kijun Sen from the bottom to the top. However, these signals, have a different degree of strength according to the position in which this signal occurs with respect to Kumo.

A weak bullish signal is recorded when the cutting of the two lines occurs below the Kumo.

A neutral bullish signal is recorded when the cutting of the two lines occurs inside the Kumo.

A strong bullish signal is recorded when the cutting of the two lines occurs above the Kumo.

The bearish signal is generated when the Tenkan Sen (black line) cuts the Kijun Sen (red line) from the top to the bottom.

A weak bearish signal is recorded when the cutting of the two lines occurs above the Kumo.

A neutral bearish signal is recorded when the cutting of the two lines occurs inside the Kumo.

A strong bearish signal is recorded when the cutting of the two lines occurs below the Kumo.

KIJUN SEN CROSS
When the price crosses the Kijun Sen, then we get this sort of signal.

The generated signal is bullish when the price cuts the Kijun Sen (red line) from the bottom to the top.

A weak bullish signal is recorded when the Kijun is cut from the price below the Kumo.

A neutral bullish signal is recorded when the Kijun is cut from the price inside the Kumo.

A strong bullish signal is recorded when the Kijun is cut from the price above the Kumo.

The generated signal is bearish when the price cuts the Kijun Sen (red line) from the top to the bottom.

A weak bearish signal is recorded when the Kijun is cut from the price above the Kumo.

A neutral bearish signal is recorded when the Kijun is cut from the price within the Kumo.

A strong bearish signal is recorded when the Kijun is cut from the price below the Kumo.

KUMO BREAKOUT
The so-called Kumo Breakout signal occurs when the price cuts one of the two extremes of the Kumo.

A bullish signal occurs when the price enters the Kumo and breaks its upper wall upward.

A bearish signal occurs when the price enters the Kumo and breaks its lower wall downward.

SENKOU SPAN CROSS

 

The Senkou Span Cross occurs when the Senkou Span A cuts the Senkou Span B.

Since the two Senkou lines are projected forward by 26 periods respect the current price, the element to be checked when the signal is realized is where the price is positioned compared to the Kumo.

The generated signal is bullish when the Senkou Span A (blue line) cuts the Senkou Span B (purple line) from the bottom to the top.

A weak bullish signal is recorded when at the cutting time between the two Senkou, prices are positioned below the Kumo.

A neutral bullish signal is recorded when at the cutting time between the two Senkou, prices are positioned inside the Kumo.

A strong bullish signal is recorded when at the cutting time between the two Senkou, prices are positioned above the Kumo.

 

The generated signal is bearish when the Senkou Span A (blue line) cuts the Senkou Span B (purple line) from the top to the bottom.

A weak bearish signal is recorded when at the cutting time between the two Senkou, prices are positioned above the Kumo.

A neutral bearish signal is recorded when at the cutting time between the two Senkou, prices are positioned inside the Kumo.

A strong bearish signal is recorded when at the cutting time between the two Senkou, prices are positioned below the Kumo.

 

CHIKOU SPAN CROSS

 

When the Chikou Span rises above or falls below the corresponding price then this signal is generated.

An important element is also represented by the inclination of the Chikou Span at the time of the observation. In fact, the Chikou positioning above or below the corresponding price is not enough; it also must have an upward inclination for bullish signals and a downward one for those bearish.

Since the Chikou is nothing more than the current closing price moved back by 26 periods, the necessary elements are: for the long trade, a Chikou above the corresponding price and, for the short trade, a Chikou below the corresponding price. The positioning of the current price compared to the Kumo then contributes to make the signal more or less powerful.

The generated signal is called bullish when the Chikou Span (yellow line) cuts the price from the bottom to the top.

A weak bullish signal is recorded when at the time of the upward cutting of the Chikou, the current price is positioned below the Kumo.

A neutral bullish signal is recorded when at the time of the upward cutting of the Chikou, the current price is positioned inside the Kumo.

A strong bullish signal is recorded when at the time of the upward cutting of the Chikou, the current price is positioned above the Kumo.

 

The generated signal is called bearish when the Chikou Span (yellow line) cuts the price from the top to the bottom.

 

A weak bearish signal is recorded when at the downward cutting time of the Chikou, the current price is positioned above the Kumo.

A neutral bearish signal is recorded when at the downward cutting time of the Chikou, the current price is positioned inside the Kumo.

A strong bearish signal is recorded when at the downward cutting time of the Chikou, the current price is positioned below the Kumo.