Ichimoku Kinko Clouds

So far we have just considered strategies that involve buying options, but bankers are more likely to be writing options. This is a bank’s natural business; they tend to buy options only to hedge existing positions, to reduce exposure, or as part of a more complex trade. The first decision when writing a call is where to pitch the strike. Strikes at new highs and new lows tend to be slightly more expensive but, as few Western people know where the Clouds are, we can use these as well as new highs and lows. Strikes at the top of the Cloud could and should be more expensive, while those within the Cloud can be pitched more cheaply. This is because the market is likely to get stuck inside the Cloud (if it is thick), using up time value. Theta (time decay) is the option seller’s friend. The second decision is when to hedge the call as it moves into-the-money. Let’s consider the example below. Short call strategy Assume we have sold a C$ 1.4000 call on the US dollar (put on the Ca

Long call strategy This is a good example for a cautious trader who wants to buy an out-of-the-money option. In this example the investor anticipates that the Australian dollar would increase in value versus the US dollar. The chart is of the number of US cents needed to buy oneAussie dollar (the level here is 0.6650, so 66 1/2 US cents). The higher the price, the stronger the Aussie. Believing it should move higher, the trader therefore wants to buy an Aussie call (the same thing as a US dollar put). First, check the Cloud and make sure the candlesticks are above the Cloud. If they are not: wait, as a lot of time value may be eroded as prices can stick under the formation for several weeks. Here the Aussie dollar did for almost two months! If they are nudging into the Cloud, and the trader really cannot resist the urge to buy, choose a call with a strike at the top edge of the Cloud and preferably above it (to the nearest round number as these are more actively traded and ther

One does not have to be a rocket scientist to understand how important price and time are in options strategies – even more so than when trading the underlying instrument. If the expiry date is too early, potential gains may be seriously curtailed or non-existent, as one has not allowed enough time for the move to map out. Choose the wrong strike price, and the market may never get there. Buy an option before an interim high or low is clearly in place and you may suffer a massive drawdown in the value of the option, plus time decay, before things then start moving in the right direction. Option buyers The timing element for both buyers and writers of options is very important. Buyers will tend to avoid initiating a trade if it looks likely that prices will move sideways for some time. In a trending market the buyer should analyze the most recent pattern, work out the price target and likely date target, and buy an option with the appropriate strike for expiry just after the day

Key to this is the idea of special numbers. Not lucky ones as 7, or unlucky 13, but ones which, from number crunching, are considered significant. We are not going into the realms of mysticism here, as those of you who are aficionados of Fibonacci retracements and projections will understand. Proportions of 0.61875 and 0.38125 are also special, but not magical (although some do believe 1.618 is divine). The Timespan Principle has three simple numbers: 9, 17 and 26 (remember, 9 and 26 are the days used for the moving averages) and are considered the most useful. • 9 is known as the ‘basic unit’ • 17 (9+9-1) is two of these basis units (the –1 is explained later) • 26 is three basic units (9+9+9-1), or one ‘term unit’. The next set of numbers are compound ones, arrived at through rough combinations of the first three. These are: • 33 (one term unit plus one basic unit), 26+9-1 • 42 (one term unit plus seventeen), 26+17-1 • 65 (is known as one ‘super big unit’, 33+33-1 • 76,

From the N Wave consolidation patterns, Price Targets are determined. Again, this should be straight-forward, as it uses measurements of the size of the whole pattern and the size of each of the waves within it.As inWestern technical analysis, the height of the triangle gives a target price for when we break out of the pattern. Similarly a head-and-shoulders pattern gives a price target and ElliottWave theory states that wave C will be in proportion to wave A lower. Ichimoku targets can only cope with the size of the very next little wave. Each consolidation pattern suggests the direction of the very next move only. It does not predict the next series of waves and long term targets as ElliottWave can do. So, one step at a time here. The Price Targets are labelled V, N, E, and NT. The first two are self-evident - being the final leg of their respective formations. E may have stemmed from the fact the pattern has two equal halves, where the last leg compensates for the dip to C, but

First, let’s look at the consolidation patterns of theWave Principle. Although there are many variations of these, they all have the same basic precepts: price ranges and wave counts, with wave sizes in proportion to each other; breakout price projections based on the sizes of the waves and the consolidation patterns. In other words, consolidation patterns can be sub-divided into a series of small waves and the size of the pattern determines the extent of the wave that follows on a break-out of the formation. Starting with the simplest wave called an “I”: a market that will either go up in a straight line or down equally steadily, often one wave following the other. Putting these two together one ends up with pattern “V”, the second simplest one, which may start with an up move which then reverses, or vice versa. Things get a little more interesting with “N”, which is a three-wave alternating combination either moving up first or down first. Then we have five wav

Now lets look at an example where the market is possibly set to reverse - the Euro against the US dollar. Pushing up into the cloud for the first time since September. Analysis With the exception of a rather dramatic three days in early September, the Cloud has limited rallies most of the time. The Cloud itself was relatively flat in November because the highest price of the last 52 days was the early September high. Note also that the Cloud has been relatively fat throughout, but has narrowed starting 10 January. Kijun-sen (26-day MA) has flattened suddenly, having dropped very steadily for a long time. The moving averages themselves have crossed, caused by the strong rally of the 10 December, and are now approaching the bottom of the Cloud which should act as resistance. Added to the last two days of consecutive candles with long upper shadows in the middle of the Cloud, this hints that we are unlikely to break higher short term, but we will watch in February for a pote

The first example we will look at will be the German Dax stock market index. Dax Index You will see that the chart below contains many gaps, because, unlike the FTSE100 and DJIA indices, the Dax can (and will often) open away from the previous day’s close. The other two indices always open at the same price as the last close and will move up or down as bargains are struck in the different shares that make up the indices. Therefore we will not pay too much attention to these gaps in our analysis, only taking note of these when especially large gaps form, or when they are to be found around very important chart levels and patterns. In an uptrend with consolidation late July to October. Analysis As can be seen from the above chart, prices had been moving steadily higher since November, after moving broadly sideways from late July to 28 October. Kijun-sen (the 26-dayMA) tended to be horizontal then, but after the 28th started moving higher at an angle just over 45 degrees -

We’ll look again at the chart we saw a little earlier. Note how quickly Chikou Span (dark green line) drops to the cloud in December, then clings within the cloud’s upper and lower boundaries. Chikou Span is used in combination with today’s candlestick: • if Chikou Span is trading above the candlestick of 26 days ago, then today’s market is said to be in a bullish long term phase; conversely, • if Chikou Span is trading below the candlestick of 26 days ago, then today’s market is in a long term bearish phase. Same idea for Chikou Span itself and the Clouds: above the Cloud of 26 days ago, then today is bullish - and vice versa. Support and resistance for Chikou Span Finally, the position of the candlesticks themselves, the moving averages, and the Clouds are also levels of support and resistance for Chikou Span. These will give suggestions where today’s support and resistance lie. The 9 and 26 day moving averages also act as support and resistance for Chikou Span. It

Remember, this is a system for markets that are trending. In sideways markets it is hopeless, as you can see in the first two thirds of the chart below of the S&P500. Moving broadly sideways from July to November so the clouds are of no use.

The distance between the Cloud and the current price is not significant. Again,Western methods often suggest that when prices are a long way from a trendline, or two averages, the market is unstable and possibly out of control. Not so with this method. In some ways it is a similar idea to that of the 26-day moving average which, when very steep, means a powerful trend in place.As a concept, it is the opposite of the Relative Strength Index, or reversion to the mean. However, when faced with soar-away price-action, I watch far more closely for reversal candlesticks. It does feel churlish to warn that ‘the end is nigh’ when others are rushing in to buy, and we all know not to count our chickens before they hatch. And powerful moves can be short-lived but take prices way beyond what anyone had hoped for. But it cannot last forever, so watch for signs of instability in the candlesticks themselves. This major market is up 25% in just one month – probably difficult to sustain. No

The thickness of the Cloud is important. The thicker the Cloud, the less likely it is that prices will manage a sustained break through it. The thinner the Cloud, and a break through has a much better chance. So, Cloud is Cloud regardless of whether Span A or Span B is on top; the thickness is what matters. Crossover points I have often been asked whether the crossover point of the Senkou Spans is important. No, other than the fact that at that point the Cloud is at its thinnest. Senkou Span B is often a horizontal, as important highs/lows remain in place for a long time. Trend reversals Thin sections in the Cloud give us an idea of when the market is likely to change trend. Look ahead and see when, and at what price, it gets very thin. Similarly, if the Cloud is getting fatter and fatter, the chance of a reversal in trend lessens looking out into the future. It gives dates (I’d say three or four days around the central day) when there is an increased chance of a succe