MACD_Kumo Breakout Strategy

Introduction

This is yet another strategy which utilizes another component of the Ichimoku Kinko Hyo indicator known as the Kumo or cloud. The Kumo acts as a support/resistance instrument and just the way a break of support or resistance leads to further price movement of a currency pair, the break of the Kumo to either side will also lead to further price movements. We should also note that when price is located within the Kumo, then the market is regarded as being range-bound or being in consolidation.

The Kumo has three components:

  1. The cloud: The cloud is bordered by:
  2. The Senkou span A
  3. The Senkou Span B above.

Both Senkou span lines border the cloud component. Sometimes the Kumo is thin, and at other times, the Kumo is thick. The thickness of the Kumo is an indication of how strongly range-bound the market is. Thick Kumos are not easily broken but when they are, they lead to great price movements.

Indicators
The two indicators used for this strategy are:

  1. The Ichimoku Kinko Hyo indicator, with emphasis on the Kumo and the bordering lines.
  2. The coloured MACD indicator.

The Strategy

It is crucial to know the strength of the Kumo break. It is also important to understand if the market is range-bound or trending. The Kumo break is defined as a situation when a candlestick breaks above the upper border of the Kumo and closes above it, or breaks below the Kumo’s lower border and closes below it.

If the candlestick breaks the borders but ends up closing inside the Kumo, this is a no-trade situation. As previously identified, the breakout move will be stronger if the Kumo is thick than if the Kumo was thin.

Even though the strategy can be traded on a time frame as low as 1 hour, it should be remembered that longer time frames produce more pips. So even if a breakout may not seem on the surface to have gone far, a simple check may reveal a move that has gone up to 100 pips before it lost steam. So as much as possible, try trading this strategy on the 4-hour chart or the daily chart.

a) Long Entry

Allow the price action to break through the Senkou span B (upper border) and attempt to pull back to the broken upper border of the Kumo. If the candle bounces off Senkou span B when the MACD histogram is blue in colour, go long at the open of the next candle. If the Chikou span is pointing upwards, it means the market is trending and will deliver a profitable move.

Kumo_long

Long trade setup with Kumo break to the upside

Take a look at the snapshot above, which is an AUDUSD daily chart. We can see the area where price action was inside the Kumo and the eventual break out of the upper border of the Kumo. The trade is initiated at the candle following the breakout candle because the breakout candle’s closing price was very close to the upper border of the Kumo. Furthermore, MACD was blue colour at that point and so the trade entry was made.

Stop Loss

The stop loss is placed a few pips below the Kumo, since the Kumo structure itself can act as a support for a long trade. We do not put the stop loss in the Kumo as a consequence; rather the stop loss is placed below the Kumo.

Take Profit

The Take Profit level in this case could have been taken two ways. Firstly, we see the evening doji star formation, which was a clear indication of a market reversal. At the same time, the MACD turned red. These two signals are clear indications to exit the long trade immediately so as not to lose all profits made. Total range of movement from entry to exit: 240 pips.

b) Short Entry

The short entry is made when the price action breaks out from the lower border of the Kumo at the same time that the MACD histogram is red in colour.

Kumo_short

Short trade setup with Kumo break to the downside

This is another daily chart which shows the typical setup. Again, the breakout is direct because it occurs right from the lower border of the Kumo, making it easy to set the trade entry point.

Stop Loss

This is set above the Kumo using the same principles as the long trade.

Take Profit

Several parameters could be used to set the Take Profit. Here, it would make a lot of sense to simply use a colour change of the MACD histogram as a benchmark for exiting the trade. Other parameters can still be used. These include:

– double or triple the stop loss
– a bullish reversal candlestick forming at the bottom of the downtrend

This strategy requires lots of practice on a demo account before being used on a live trade.

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