Moving averages

Candlesticks with moving averages

Once the daily candles are drawn, the next thing to do is add two moving averages. These are used in the same way as we do in the West, with crossovers giving buy or sell signals. When the short term average is above the longer term one, the trend is to higher prices; when the short term average drops below the longer one, that is a sell signal. A position is held until these reverse.

Based purely on moving average crossovers, one would currently be long since early November.

For Ichimoku charts we use two specific moving averages which are:
1. Tenkan-sen (“Conversion Line”): is a nine-day moving average, and
2. Kijun-sen (“Base Line”): is a twenty six-day moving average.
As usual, the shorter moving average whips around the longer one, giving points at which positions should be switched from long to short and vice-versa.

The origins of 9 and 26 days as the moving average periods

The number of days used are related to the fact that in Japan they used to work a six day week, Monday to Saturday, so that there is an average of 26 working days in a typical month. This eriod became the standard moving average. While, by trial and error, and exhaustive manual back-testing, nine days was found to give the best results when used in conjunction with 26 days. I feel sorry for the students who did all the legwork (pre-computers); and I believe they had to sign confidentiality agreements when working on this tedious task.

Moving averages as support and resistance levels

Another difference between Western methods and this one is that the averages, as well as telling you what trend you are in, are also in themselves support and resistance levels. For example, in a bullmarket (koten in Japanese) pricesmay stall and consolidate on the way up. How far they are likely to pull back will depend on, among other things, where the averages lie. The nine day average should usually be the line closest to current price, and will therefore be the first area of support limiting the pull-back. The twenty-six day moving average should be further from current price levels, and is a more important area of support. Prices often haul themselves up from here in bull markets but, if they don’t, this is the first warning signal of a potential turn in trend.
In a bear market (gyakuten in Japanese) the same rules hold.

A very steady bull market where one would have held a long position since mid-September.

The degree of slope reflects the strength of the trend

Note also that the slope of the 26-day average is also fairly important. The steeper it is in a downtrend or an uptrend, the more powerful the current trend and the more likely it is to continue. However, if it is moving very gently lower/higher, and especially if it is flat, then one assumes that there is no overall trend. An angle of between 33 and 45 degrees is great. This is regardless of moving average crossovers. For example, see EUR/GBP in the next chart.

Swinging randomly one penny either side of £0.6820.

As you can see in the chart above, this method really does not work for markets that are not trending. The green line is the 26-day moving average which has been pretty much flat-lining since September. Ichimoku charts are therefore very much a trend-following system.

Looking ahead

As well as for the averages nine and twenty six days ahead are also used as potential stalling points within a larger move. Assuming an important high was formed on today’s chart, Japanese traders will pinpoint nine and twenty six working days ahead, and watch these dates for signs that a smaller wave within one of a larger degree has ended.
For some reason they also sometimes use eighteen days (which is not 26-9).

This concept may be familiar for those of you who use Cycle Theory. This method again starts with an important high or low, and projects forward in time Fibonacci numbers’worth of days. Where a series of cycles meet on a particular day in the future, there is a greater chance of forming important highs or lows.