How to use our strategies (PLEASE READ FIRST)
While I fully appreciate as with all things trading people want to skip the boring stuff and jump straight onto the how do I make money part. I will cover a whole section on money management and risk within this series which I highly recommend you read before actually actively applying any of the strategies. But before we get into anything juicy, I wanted to highlight the importance of applying a system correctly.
One of the key things that I have learned over my trading career is that trading is a marathon not a sprint. It is about longevity and consistent gains over time, not a system which is going to make you rich over night and enable you to quit your job tomorrow (such a strategy does not exist). It is imperative that you understand just because a system is profitable over time does not mean that it will not have losing trades, losing days, weeks or even months. This is something that I we will investigate in more depth later on but a concept that is crucial to your success.
A Little Theory
If you have been following our other trending based strategies you would of by now seen there is a common theme. The market has three potential behaviour patterns, it can move up, down or sideways. The basis of most of our trending systems is pretty simple and obvious. Buy when the market is moving up, sell when it is moving down and stay out when it is moving sideways. The Cloud system theory is exactly the same, its success lies in its ability to keep you out the market when it is choppy yet gets you in quickly if the market is moving.
The Cloud system uses an ichimoku indicator in order to filter these different phases. Sounds complicated? Well its actually pretty straight forward as the indicator does all the hard work for you.
First off we need to look at the indicator its self. Most MT4 platforms have it as an in built indicator and it is pretty straight forward to setup.
Applying the indicator to a 1 hour chart, you can use 4 hour or daily but I find that the 1 hour is optimum. Click Insert, Trend, ichimoku Kinko Hyo.
We will be keeping the settings as default but just removing a few of the lines as we will not be using all of them. Your indicator settings screen should look like this.
Once thats done you should have a chart that looks something like this.
As you can see we are left with the cloud like patterns and the Kijun-Sen line which from now on we will just refer to as the Kline.
Reading The Indicator
At first glance the chart looks a little confusing but we are going to break it down into a very simple way to understand and see whats going on. In a nutshell price above the cloud is bullish and price below the cloud is bearish.
Price in the cloud is either reversing or in that sideways motion we mentioned earlier. One other thing to note is the width of the cloud, the wider the cloud span the stronger the trend the narrower and more like spaghetti it looks the weaker and more range bound the market is.
Next we have the Kline, the Kline we are going to use for out stop placement and also for a filter of our entry signal.
There are 4 conditions that need to be met in order to enter a trade. First off lets look at a buy entry.
1) Price needs to be above the cloud.
2) Price needs to be above the K-line.
3) The K-line needs to be above the cloud.
4) The previous swing point above the cloud needs to be taken out.
At point 1 price is above the cloud and above the K-line so we have a long trade setting up but that is only 2 of our conditions met. Point 2 is where the K-line crosses above the cloud meeting another condition now we just need to see the previous pivot (dotted line) above the cloud be broken to give an entry. At point 3 we see the breakout happen and another pivot form, the long entry goes above this point (green line). Stop loss goes at the lowest level of the retracement (red line). The trade then triggers and up it goes. Once the K-line is higher than the original stop loss your stop should be trailed along the K-Line. As you can see in point 4 is when you would of been stopped out on this trade.
A short entry is just simply the inverse of the long setup. Again we have 4 conditions that need to be met.
1) Price below the cloud.
2) Price below the K-Line.
3) K-Line below the cloud.
4) The previous swing long needs to be taken out.
At point one price is below the K-Line and below the cloud meeting our first 2 conditions. Point 2 shows the 3rd condition being met as the K-Line is crosses below the cloud. Now all we need to see is the previous pivot low below the cloud get broken and we will has a short setup. The blue line shows the pivot that does this entry at the blue line stop goes at the highest point of the pull back which is the red line. Once the K-Line passes the original stop location you should trail your stop along the K-Line. The green circles shows where you would of been stopped out for a nice profit.
The Void Level
The void level is the point where if the trade does not trigger then it gets canceled. If price crosses the K-Line in the opposite direct to the trade setup then that will in fact void the trade. You would then need to see price cross back through the K-Line in the correct direction and take out the previous swing point again in order to get a new setup.
The above example shows a long trade void. This is a great example of how the cloud system is able to avoid choppy conditions. Point 1 shows the initial breakout price is above the cloud and the K-Line, the K-Line is above the cloud and the previous pivot has been broken so all the criteria for a long entry. Price then pulls back and crosses below the K-Line this voids our long trade. Price then crosses back through the K-Line and the previous pivot at point 1 is broken giving another opportunity for a long trade entry. Order would be pending above the blue line but once again it pulls back and crosses the K-Line voiding the trade.
So after we have managed to avoid getting chopped around finally for a 3rd time price breaks above the cloud. Price is above the cloud and above the K-Line. The K-Line is above the cloud and the previous pivot get broken giving us a long entry above the blue line at point 3. Stop goes below the red line and this time the trade triggers and we catch a nice trending move. Stop is trailed in the usual way along the K-Line until we are stopped out at the green circle for a nice profit.