Ichimoku trading: what can go wrong

I know that many Maven readers are keen to start using Ichimoku signals on their charts following my email two weeks ago.

You can still catch my explanation on the website HERE.

And here’s a brief recap of what you need to know…

So, the red and blue lines on the example above are fast and slow Ichimoku moving averages, and we’re looking for them to cross.

We also want to be above the cloud for a buy, or below the cloud for a sell.

Plus, we have to keep half an eye on that purple line, too.

So, do Ichimoku signals work?

Well, on the chart I picked above, they work just fine. But if Ichimoku was some amazing fail-safe trade signal that only ever gave us winning trades you can be sure that they wouldn’t be as rarely used as they are!

Ichimoku charts have their fair share of false signals.

But, as with any technical tool, if we understand their weaknesses, we can prepare and protect ourselves.

The main grumble with Ichimoku is that which I hear about any kind of moving average system: the indicators lag, and by the time we’ve got the signal, the move is over.

And if the price retraces, the indicator is too slow to warn us.

A moving average reacts to past price behaviour, so it will always be playing catch-up to the price action.

Here’s an example, where we get a clear buy signal, swiftly followed by the trend coming to an end…

Ichimoku trading: what can go wrong

A good way to back-up our Ichimoku signals is by watching price action.

Above, if we look a little closer, we can see that we’ve bought just as the price is approaching a big round number (9,000) – this is never a great idea.

We then get a good warning that the price is going to turn on this round number with that gravestone doji slap bang on the 9,000 level.

So, there were plenty of clues that we should have got out of this trade rapidly (or not got into it at all).

The problem with trends

Trends, as we learned in day one of trading kindergarten, are our friends.

If we jump on board them, they’ll reap us great rewards. There are few things that feel better than a trend-following indicator giving you a signal and then the market shooting off in the right direction for hundreds of points.

It’s the trading equivalent to driving an open-top car on a sunny day with the wind in your hair.

But when we get a correction on our trend… well, too often we’re caught out and rapidly give back the profits we’ve gained.

Trend-following strategies are brilliant in a trend. But put some zigzag action into the price and they’ll give us false signal after false signal.

So, how can we protect ourselves?

My preferred solution to this problem is one that demands patience and discipline. It means sometimes sitting out of moves, which can be frustrating, but it does give the best protection I’ve found against false entry signals.

Here’s the plan…

  • We use our trend-following signal to alert us to a new trend setting up.
  • However, we know that our trend-following signal is slow to react and prone to false signals, so we won’t act immediately.
  • We wait for a price correction, testing previous support/resistance.
  • When the price then bounces back from this level with some positive price action, we’ve confirmation of our trend – and we pounce.

This plan will work for any trend-following strategy, but here’s how it plays out on Ichimoku charts…

Ichimoku trading: what can go wrong

While this method means missing out on a portion of a move, it makes our entry significantly safer.

Now, we could get a bit smarter with our entry at ‘A’ by switching down to a shorter timeframe. The chart above is 4-hourly. But if I switch to 1-hourly, when we get that bounce on 5 November, it looks like this…

Ichimoku trading: what can go wrong

This time, we wait a little longer for our entry, and get in at roughly the same level marked ‘B’ on the 4-hourly chart. This gives us extra confirmation, and can often get us in at a better price.

My Ichimoku checklist:

  • Cut losses fast, using the Kijun or even the Tenkan (slow and fast moving averages) as stop levels. This may see you bumped out of trades often, giving you lots of small losses, so ensure that when you get a winning trade, you let it really run by moving your stop level with the moving average.
  • These trades need some managing, so pick a timeframe that you can reasonably follow.
  • Remember, the Ichimoku signals are lagging – if you can read something in the price action, it can give you advance warning of what’s about to happen. Check for periods when the moving average lines go horizontal – this usually means that there is a consolidation pattern forming. Watch this price action closely.
  • With all the Ichimoku lines on your charts, it’s easy to forget about key areas of support and resistance, like round numbers or historical levels. Draw these up on your charts, and watch for price action around them.

I hope all these provisos haven’t put you off Ichimoku trading. I really just want you to have all the information. It’s easy to get carried away by a few great signals, but all indicators have weaknesses.

The great thing about Ichimoku is that it gives us so much information in one glance. The trick is to remember price action, and to remember that your Ichimoku lines will always be lagging behind that action.

This article first appeared on Forex! Forex! Forex!. Read more and comment here