Mastering Ichimoku Clouds: The Holy Grail Series, #0

By S. Fanous

Summary of "Mastering Ichimoku Clouds for Market Analysis"

Fundamental Assumptions in Technical Analysis

The Market Discounts Everything: This principle suggests that all available information, including news, earnings reports, and other data, is already reflected in the price of a security.

Prices Move in Trends: According to this assumption, prices tend to move in observable trends, either upward, downward, or sideways.

History Tends to Repeat Itself: This assumption is based on the idea that human behavior is consistent over time. As a result, historical price patterns tend to repeat, making it possible to predict future movements based on the past.

Origins of Ichimoku Clouds

Components of the Ichimoku Cloud System

Tenkan-sen (Conversion Line): The Tenkan-sen is calculated by averaging the highest high and the lowest low over the past nine periods. It indicates short-term price momentum.

Kijun-sen (Base Line): The Kijun-sen is calculated by averaging the highest high and the lowest low over the past 26 periods. It serves as an indicator of medium-term momentum and potential support/resistance levels.

Senkou Span A (Leading Span A): This line is calculated by averaging the Tenkan-sen and Kijun-sen, plotted 26 periods ahead. It forms one boundary of the Kumo.

Senkou Span B (Leading Span B): Calculated by averaging the highest high and lowest low over the past 52 periods and plotted 26 periods ahead, it forms the other boundary of the Kumo.

Chikou Span (Lagging Span): This is the current closing price plotted 26 periods back. It helps confirm trends when compared to past prices.

Kumo (Cloud): The area between Senkou Span A and B, representing support and resistance levels. The Kumo's thickness indicates market volatility.

Comprehensive Analysis of Ichimoku Clouds

Chart Setup and Timeframe Selection Setting up Ichimoku Clouds involves selecting appropriate chart timeframes based on trading style (e.g., daily charts for long-term analysis, hourly charts for short-term trading) and ensuring all Ichimoku components are correctly plotted.

A concise review of the key principles and components of the Ichimoku system, emphasizing their interrelated functions and collective utility in market analysis.

Suggested Indicators to Combine with Ichimoku Clouds

Relative Strength Index (RSI): RSI helps confirm trend strength and identify overbought/oversold conditions.

Moving Average Convergence Divergence (MACD): MACD is used to confirm trend direction.

Stochastic Momentum Index (SMI): SMI refines momentum indicators to spot entry and exit points.

Bollinger Bands: Bollinger Bands help identify breakout points and gauge volatility.

Multiple Timeframe Analysis
Trend Following Strategies
Reversal Strategies

• Language: English
• Publisher: S. Fanous
• Release date: Jun 23, 2024
• ISBN: 9798227518491

S. Fanous

Sherif is a seasoned mechanical engineer and an experienced trader with a rich history in the financial markets. Since beginning his trading journey in 1998, and executed his first options trade in 2001, marking the start of a deep and enduring interest in this complex financial instrument. His dedication to understanding market dynamics is further demonstrated by his pursuit of the CFA designation up to Level 2 of the program. As an accomplished author, Sherif has penned insightful books on trading, sharing his wealth of knowledge and practical strategies. He actively guide traders in managing their portfolios and selecting stocks, offering valuable advice and mentorship. In addition, Sherif produces a weekly report on gold , providing in-depth analysis and market insights to help traders make informed decisions. With a solid foundation in both engineering and finance, Sherif combines analytical rigor with strategic acumen to navigate the markets effectively. This unique blend of skills and experiences has equipped him with the insights and expertise needed to educate and guide others in the world of trading and investments.

Book preview

Chapter 1: Introduction to Technical Analysis

What is Technical Analysis?

Technical analysis is a method used by traders and investors to evaluate securities and make trading decisions by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysis, which focuses on evaluating a company's financial health and performance, technical analysis focuses on patterns of price movements, trading signals, and various other analytical charting tools to predict future market trends.

At its core, technical analysis operates on three fundamental assumptions. These have been thoroughly covered in two other books in this series, Introduction to Technical Analysis and Advanced Technical Analysis Strategies. Due to their importance, I will briefly state them here. These assumptions should always be at the forefront of every trader's mind when making any decision, whether it is buying, selling, exiting a position with a profit or loss, or even staying on the sidelines.

Technical analysis operates on three fundamental assumptions: the market discounts everything, prices move in trends, and history tends to repeat itself.

Fundamental Assumptions in Technical Analysis

The Market Discounts Everything:

This means that all known information is already reflected in the price of a security.

Understanding the Concept

The Market Discounts Everything is fundamental to technical analysis. It is a principle asserting that all available information, both public and private, is already reflected in the current price of a security. This includes fundamental factors such as earnings, dividends, and growth prospects, as well as market sentiment, geopolitical events, and economic indicators. The price at any given moment represents a consensus of all market participants, incorporating their collective knowledge, expectations, and emotional responses.

This concept is rooted in the Efficient Market Hypothesis (EMH), which posits that it is impossible to consistently achieve higher returns than average market returns on a risk-adjusted basis because asset prices already incorporate all known information. Thus, technical analysts believe that by studying price movements and trading volumes, they can gain insights into future price behavior, as these metrics reflect the aggregated actions and reactions of all market players.

Understanding that the market discounts everything underscores the importance of focusing on price action and market trends rather than reacting to news and events that are already factored into the current price. This principle is crucial for maintaining a disciplined approach to trading and avoiding common psychological pitfalls.

Pitfalls of Ignoring The Market Discounts Everything

Despite understanding the concept, traders often fall into common traps that can lead to significant losses. Here are several examples illustrating these pitfalls:

Chasing the News: A trader sees positive news about a stock, such as a company reporting higher-than-expected earnings or announcing a new product launch. Excited by the news, the trader immediately buys the stock, expecting it to surge. However, the stock retreats shortly after the purchase. This happens because the positive news was already anticipated and priced in by the market. Savvy investors had already acted on the information before it became public, leading to a classic buy the rumor, sell the news scenario. As a result, the trader faces losses from buying at a peak price point.

Ignoring Technical Signals: A trader relies solely on fundamental analysis and ignores technical signals such as overbought or oversold conditions. For instance, a stock might be fundamentally strong with robust earnings growth, but if technical indicators like the Relative Strength Index (RSI) show it is overbought, a correction could be imminent. Ignoring this technical signal, the trader buys the stock, only to see it decline as the market corrects itself, reflecting that the positive fundamentals were already factored into the price.

Underestimating Market Sentiment: Positive economic data is released, indicating a strong economy. Believing this will boost stock prices, the trader goes long on multiple stocks. However, market sentiment is currently driven by geopolitical tensions or fears of an impending recession, causing investors to remain cautious. Despite the good economic data, stock prices decline due to the prevailing negative sentiment. The trader’s failure to recognize that the market had already discounted the economic data and was focusing on other factors leads to unexpected losses.

Late Reaction to Earnings Announcements: A company reports excellent quarterly earnings, far exceeding analysts’ expectations. Enthusiastic about the earnings beat, a trader buys the stock the following day. However, the stock price falls instead of rising. This occurs because institutional investors and well-informed traders had anticipated the positive earnings and bought the stock weeks in advance, driving up the price. When the actual earnings were announced, they took profits, causing the price to drop. The trader’s late reaction results in buying at a high and facing immediate losses.

Overconfidence in Analyst Ratings: A trader follows a highly respected analyst who upgrades a stock from Hold to Buy, predicting substantial future gains. Convinced by the analyst’s reputation, the trader buys the stock. However, the stock fails to rise as expected and may even decline. The market had already priced in the potential upgrade based on the company's previous performance and news flow. As a result, the trader experiences losses due to overreliance on the analyst's recommendation without considering that the market had already discounted this information.

Ignoring Broader Market Trends: A trader focuses on a single stock's positive news and fundamentals without considering the broader market context. For example, even if a company reports strong growth, if the overall market is in a bearish trend due to macroeconomic concerns like rising interest rates or political instability, individual stocks are likely to be dragged down. The trader buys the stock, expecting it to rise on its positive fundamentals, but instead, the stock follows the broader market downtrend, leading to losses.

Failure to Recognize Insider Selling: A trader notices a well-performing stock and decides to buy, seeing it as a good investment opportunity. However, they overlook insider selling reports, where company executives are offloading shares. This insider activity often indicates that those with the most knowledge about the company's future prospects believe the stock is overvalued. The trader buys in, only to watch the stock decline as more insiders sell, reflecting that the market had already accounted for the upcoming downturn.

By understanding