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Avoid the Trading Trap of Fake Reversals with Ichimoku

Avoid the Trading Trap of Fake Reversals with Ichimoku

2013-06-25 03:00:00
Tyler Yell, CMT, Currency Strategist
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Account Equity:There are many moving parts of Ichimoku. Each part has its own specific purpose. This article will walk you through the critical points of Ichimoku that can help you confirm whether a trend has likely reversed or not. By using Ichimoku as a trend reversal confirmation tool, you can stay out of bad trades that trap other traders. When you can identify and avoid false reversals, you will be able to jump onto a trend at some of the best entry points possible.

"I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms."

-Paul Tudor Jones, Founder of Tudor Investment Corporation

There is a clear reason why traders want to trade reversals. There’s a lot of money to be found when you pick the right reversal and hold it to completion. Many traders may even tell you that trend reversal trading is a dangerous game that is best left to others.

However, the trend trading system known as the “one glance” indicator or Ichimoku can help you with this profitable set up. While no person or indicator can guarantee you’ll correctly catch every reversal in every market, the filter factor of Ichimoku will play a key role. Lastly, because Ichimoku works on all time frames with all instruments, you can use this key aspect of Ichimoku to trade how you want on the time frame you’re most comfortable trading.

The Fractal Nature of Markets & Ichimoku

Saying that the market is fractal is a fancy way of saying that markets tend to play out price patterns very similarly over multiple time periods. This means that a trading chart could be on a one minute, 1 day or month candlestick setting of displaying price and the trade set up triggers would be the exact same. This is helpful for you because regardless of your preference of how long to hold a trade, this lesson can work for you.

Learn Forex: The Fractal Nature of Forex Means There Is Opportunity for All

Avoid the Trading Trap of Fake Reversals with Ichimoku

Chart Created by Tyler Yell, CMT

Above, you see the same currency pair of $USDJPY with a similar short trade set up over very different time frames. The first chart on the left, 15 minute chart would have you in and out likely within the trading day. The second chart with 4-hour candles would likely have you holding the trade in a swing fashion where the trade would be open for 1-2 weeks.

The purpose of this information is that trend reversals, which often birth new trends can happen on any chart time frame you prefer. Now that we know that this can be used on all time frames we can look for the factors of Ichimoku that help us capture the trends in the earliest stages of a reversal.

Using the Cloud & Lagging Line Together To Target Reversals

When trading with Ichimoku, we first look to the cloud to get an understanding of the current trend. When price breaks from one side of the cloud to the other, we begin to look for a reversal. However, the reversal isn’t complete until we get a confirmation signal which we will receive only from the lagging line.

Learn Forex: Price Breaking Through the Cloud Alone Isn’t a Full Signal

Avoid the Trading Trap of Fake Reversals with Ichimoku

Chart Created by Tyler Yell, CMT

As you can imagine, traders have been yearning to buy the bottom on AUDUSD since it dropped below 1.0200 in April. On the chart above, you can see the strong trend that has only taken small rest stops on the way down to 0.9150. The key point is that when many traders may have believed that the bottom had been formed, they likely got in at a horrible price that dropped their account equity.

Utilizing the lagging line as a confirmation tool helps you immensely on trends like this and countless others. On the AUDUSD chart above, you could have either stayed on the sideline or not bought the AUDUSD because you did not receive confirmation which would have been kind to your account equity. Conversely, you may have added to your short position as the false signal in one direction is a great signal in the other but either way; the lagging line was a great tool to give you an additional edge and method to prevent you from entering off a simple trend correction as opposed to a reversal.

What Is A Lagging Line?

The lagging line takes the close of the current bar and shows you how it stacks up against price 26 periods ago to give you a clear picture of the strength or weakness of a currency pair. Earlier, we discussed how trading set ups transcend all time frames so that you can trade on the time frame that suits you best. The lagging line will be 26 minutes, hours, or days behind the current candle depending solely on the chart you’re trading on and it is equally effective.

Ichimoku Weekly Trade: SELL GBPUSD with Lagging Line & Price below the Cloud

Avoid the Trading Trap of Fake Reversals with Ichimoku

Chart Created by Tyler Yell, CMT

Ichimoku Trade: Sell GBPUSD as all Ichimoku rules abide for a short trade

Stop: 1.5575 (Bottom of the Bearish Cloud & Above Base Line)

Limit: 1.5125 (as of current price, sets our limit at 1.75 times our risk)

Much has been made of the recent strength in the GBP over the last few weeks but the USD has been stronger on a relative basis. This has a lot to do with the Federal Reserve mentioning a stronger economy is forming which would lessen he need for Quantitative Easing which has kept the USD weak lately. If QE really does end in the US, then many traders will look to buy USD across the board against weaker currencies.

Happy Trading!

---Written by Tyler Yell, Trading Instructor

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