Trading strategy: Ichimoku KBO

Description

The Ichimoku Kumo Break-out strategy (KBO) is one of the lesser known strategies within the Ichimoku system developed by Goichi Hosoda. Ichimoku is a finely-tuned, integrated charting system where 5 lines all work in concert to produce buy and sell signals. It is used extensively in Asian trading rooms but only started to appear in the West in the 1990s. Several strategies are derived from the Ichimoku system. Ichimoku KBO is one of them.


  
Suitable for : Forex (EUR/USD …)
: Indices (FTSE, CAC, DAX ...)
: Commodities (Oil, Gold, …)
: Stocks
Instruments : Futures, CFDs and Forex
Trading type : Swing trading
Trading tempo : Low - Depending on time frame
The strategy : Video
Using NanoTrader Full : Manual or semi-automated

 

The strategy in detail

The Ichimoku charting system consists of 5 separate indicators (lines). 4 Of these lines are based on different time frames:

Tenkan Sen (turning line): An average of the highest highs and lowest lows over the last 9 periods. This line represents a price equilibrium level over the last 9 periods. Tenkan Sen measures short-term momentum and can be interpreted in the same manner as a moving average.

Kijun Sen (standard line): An average of the highest highs and lowest lows over the last 26 periods. This line represents a price equilibrium level over the last 26 periods. Because of its longer period, Kijun Sen is more a measure of momentum than Tenkan Sen. A flat Kijun Sen indicates a range bound price. A sloped Kijun Sen indicates a trend, with the slope of the line indicating the trend’s momentum.

 

In this screenshot the Tenkan Sen (red)  is a support for the downtrend from A to B and for the uptrend from B to C. The flat Kijun Sen (blue) indicates a trading range. A sloped Kijun Sen indicates momentum.


Senkou Span A (1st leading line): An average of Tenkan Sen and Kijun Sen, plotted 26 periods ahead. The average of Tenkan Sen and Kijun Sen indicates medium term price equilibrium level with support and resistance levels. Time-shifting this line forward makes it easy to compare prices today with prior support and resistance levels.

Senkou Span B (2nd leading line): An average of the highest highs and the lowest lows over the last 52 periods, i.e. the mid-point of the range of prices over the last 52 periods, plotted 26 periods ahead. Senkou Span B measures the price’s long-term momentum.

The area between Senkou Span A and Senkou Span B is called Kumo, the cloud. The cloud is colored in red when the trend is bearish (Senkou Span A is below Senkou Span B). The cloud is colored in green when the trend is bullish (Senkou Span A is above Senkou Span B).

 

In this screenshot both a bullish and bearish cloud (Kumo) are visible.


Chikou Span (lagging line): it represents the current closing price time-shifted backwards by 26 periods. While the rationale behind this may at first appear confusing, it becomes very clear once we consider that it allows traders to quickly see how today’s price action compares to the price action of 26 periods ago

Several publications give different descriptions of the various strategies that can be derived from the exploitation of the Ichimoku charting system. The Ichimoku KBO strategy detailed in this text is based on the market breaking out of the clouds.  The text shows the strategy applied in a 1-day time frame. The strategy can also be applied in a 1-week time frame.

When to open a position?

A buy signal is generated when the market closes above a cloud’s upper border. A sell signal is generated when the market closes below a cloud’s lower border.

 

In this example the market has crossed through and closed above the cloud's upper edge. This is a buy signal. Note: to make it easy to identify these occurrences the chart background is colored green. There is a second buy signal several days later. Given that we already have an open position the signal is not relevant.


 

In this example the market has crossed through and closed below the cloud's lower edge. This is a short sell signal. Note: to make it easy to identify these occurrences the chart background is colored red. There is a second short sell signal several days later. Given that we already have an open position the signal is not relevant.

When to close a position?

The Ichimoku KBO strategy relies solely on a stop.  The stop follows the lower edge of a cloud in the case of a long position and the upper edge of a cloud in the case of a short position.

 

In this example a long position is opened when the market breaks upwards out of the cloud. Six days later the position is stopped out with a loss.


 

In this example a short position is opened when the market breaks downwards out of a cloud. Two months later the stop is touched and the position is closed with a small profit.


Attention. This last example seems to be a frequent scenario with the Ichimoku KBO strategy. At the beginning the position evolves very favourably only to be closed later with only a small profit or even a loss. Traders might want to explore a trailing stop, a time stop or some other similar tool to remedy this issue.

 

Conclusion

Ichimoku KBO is a break-out strategy based on the five Ichimoku trend lines and the "clouds" they form. The clouds represents a medium term zone of price equilibrium. When the market breaks out of the cloud the probability of the market starting a strong trend is considered high. Ichimoku is used in all financial centers and information about the system can be found in numerous publications. It is nevertheless important to carefully analyze the historic results of the strategy on the instrument(s) you wish to trade before putting it into practice. The strategy can be used for market indices, forex, commodities, individual shares, etc. Large time frames such as days and weeks tend to give the better results.

Practical implementation

In NanoTrader Full follow these steps:
  • Choose the instrument you wish to trade.

  • Open a chart with the template study "WHS Ichimoku KBO".

  • Change the time frame to 1 week if you prefer it to 1 day.

  • Semi-automated trading? Simply activate the TradeGuard+AutoOrder or the AutoOrder function.