Ichimoku ChartingAn Introduction

Jason PerlGlobal Head: Fixed Income, Rates & Currencies Technical Strategy GroupUBS Investment Bank

Telephone : +44 20 7567 2447E-mail : jason.perl@ubs.com

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ICHIMOKU KINKO HYO : INTRODUCTION

� Developed by Goichi Hasoda

� Outlined the theory in his book Ichimoku Charting in 1969

� Ichimoku - at a glance, Kinko - balance, Hyo - charts

� Widely used in Japan

� Can be applied to any market or time frame

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ICHIMOKU : THE LINES

� CONVERSION LINE Tenkan-sen

� BASE LINE Kijun-sen

� LAGGING SPAN Chikou Span

� LEADING SPAN 1 Senkou Span 1

� LEADING SPAN 2 Senkou Span 2

� OPEN, HIGH, LOW, CLOSE

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ICHIMOKU : DERIVING THE LINES

� CONVERSION LINE (Highest high [9] + Lowest low [9]) / 2

� BASE LINE (Highest high [26] + Lowest low [26]) / 2

� LAGGING SPAN Current price shifted back 26 periods

� LEADING SPAN 1 (Base Line + Conversion Line) / 2)Shifted forward 26 periods

� LEADING SPAN 2 (Highest high [52] + Lowest low [52]) / 2 Shifted forward 26 periods

� CLOUD Shaded area between Leading Span1and Leading Span2

� OPEN, HIGH, LOW, CLOSE

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ICHIMOKU : INTERPRETING THE LINES

� BASE / CONVERSION LINES give buy and sell signals as with regular moving averages.

� CLOUD if today�s price > Cloud, the implication is higher prices. Top of Cloud represents first level of support while bottom of Cloud is the secondary support. If today�s price < Cloud, the implication is lower prices. Bottom of Cloud should then offer initial resistance, while top of Cloud should provide secondary resistance.

� CLOUD DENSITY the thicker the cloud, i.e. the greater the distance between Senkou Span1 and Senkou Span 2, the less likely the probability that price will breakthrough the secondary level.Breakouts are more likely when theCloud is very thin.

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ICHIMOKU : INTERPRETING THE LINES

� LAGGING SPAN is used in conjunction with the current bar. If the Lagging Span is trading above the bar of 26 periods ago, the market is in a bullish phase. If the Lagging Span is trading below the bar of 26 periods ago, the market is in a bearish phase.

The position of the Lagging Spanrelative to the corresponding Cloud isalso important as it will help define the current support / resistance levelsdepending on whether it is above /below or inside the Cloud.

In a bull market, the Cloud offers strong support, while providing solid resistance in a bear market.

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ICHIMOKU : EUR/USD DAILY CHART - EXAMPLE

Current O, H, L, C

Lagging Span

Conversion Line

Base Line

Leading Span 2

Leading Span 1

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ICHIMOKU : USD/JPY DAILY CHART - EXAMPLE

In the example above, it�s interesting that although price was above all of the lines at one stage, an impulsive upside breakout was unlikely because the Cloud relative to the corresponding Lagging Span was very thick. Any bullish strategy initiated at that point would therefore have to take into account the length of time before the Cloud relative to the Lagging Span dropped away sharply to the downside. This is particularly important for cash trades where negative carry needs to be taken into consideration or options trades where time decay is an important factor.

Cloud is very thick relative to Lagging Span, thereby reducing likelihood of near-term upside breakout.

Price has broken Cloud but Lagging Span corresponding to Cloud is still very thick, which reduces likelihood upside break will be sustained

Cloud starts to fall away sharply -highlighting the first point where an upside break is most likely to occur

Simultaneous break of Cloud support by both price and Lagging Span initiates sharp sell-off

Simultaneous break of Cloud support by both price and Lagging Span initiates sharp sell-off

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ICHIMOKU : USD/JPY DAILY CHART - EXAMPLE

Price violates Cloud support first but break only becomes impulsive to the downside once the Lagging Span breaks below its Cloud support.

Lagging Span violates Cloud support first but break becomes impulsive to the downside once the price breaks below its Cloud support.

Both of the examples above emphasise the need for both the Lagging Span and current price to break their respective Cloud supports to reduce the short-term whipsaw risk. In the first example, price moved lower first and the ensuing bounce prior to the break by the Lagging Span was fairly minimal. However, in the second example, where price closes above the top of the Cloud, the corresponding Lagging Span doesn�t manage to do so resulting in a sharp pullback. the Lagging Span broke Cloud support first.

Price breaks through the Cloud but corresponding Lagging Span fails to do so - ensuing failure highlights the importance of waiting for confirmation from both.

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ICHIMOKU : USD/JPY - INTRA-DAY CHART

Note how Cloud relative to Lagging Span starts to fall away sharply, thereby increasing prospect of a near-term break to the upside. The fact that Leading Span 1 crosses above Leading Span 2 going forwards adds credence to this scenario.

Breakdown becomes impulsive once price and Lagging Span break below Cloud Support. Note how the Base Line subsequently becomes resistance going forwards.

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ICHIMOKU : EUR/USD - DAILY CHART

Note, price breaks through Cloud but Lagging Span (which is approaching thick Cloud support fails to do so on a closing basis. Waiting for confirmation rather before establishing strategic short positions would have avoided subsequent sharp rebound.

Again, price spikes below Cloud support but the Lagging Span needs to close below its Cloud support to initiate an impulsive breakdown. Since Cloud relative to Lagging Span at that point is fairly thick, it reduces the probability of a sharp move lower at that point in time.

Both price and Chikou finally break Cloud support simultaneously

In the first two instances below (September-02 and April-03, market sentiment towards the Euro became quite negative. However, the Cloud relative to the Lagging Span at that point in time was relatively thick and suggested that an impulsive breakdown was unlikely unless / until the Lagging Span also broke below its corresponding Cloud support on a closing basis. Waiting for this additional evidence would have avoided selling ahead of a resumption of the up-trend. Finally, downtrend accelerated when both broke simultaneously.

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ICHIMOKU : DXY (CASH) - MONTHLY CHART

NOTE: At the end of November 2003, both the price and Lagging Span closed below their respective Cloud supports, suggesting further weakening of the USD over the medium-term.

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ICHIMOKU : GBP/USD - MONTHLY CHART

While price had broken Cloud resistance on several occasions, it was in September 2003 that both price and Lagging Span broke their respective monthly Cloud resistances. NOTE: price and Lagging Span had not been above their Clouds since 1992.

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ICHIMOKU : GBP/USD - DAILY CHART

Daily price and Lagging Span break of Cloud resistance provide early signal ahead of monthly break at end of November.

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ICHIMOKU : AUD/USD - DAILY CHART

NOTE: Although price broke through Cloud support, the Lagging Span held its corresponding Cloud support, suggesting price sell-off was most likely a false break.

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ICHIMOKU : EUR/JPY - DAILY CHART

Price above Cloud resistance, waiting for confirmation from Lagging Span relative to its Cloud resistance.

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ICHIMOKU : NIKKEI 225 (CASH) - DAILY CHART

Note: At the end of May 2003, both the current price and Chikou broke above their respective Cloud resistance levels simultaneously for the first time since February 2002, thereby signalling a significant breakout to the upside. Upside breaks up until that point were false breaks as price had broken without confirmation from Chikou.

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ICHIMOKU : S&P (FUTURE) CONTINUATION CHART

Note how critical Cloud support has been for last 4 significant sell-offs in S&P.

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