Predicting leading U.S. energy stock prices using Ichimoku Cloud

  • January 2021
  • Energy stocks and Financial Markets

The Ichimoku Cloud is formed as a trading system, using daily stock prices of the top ten constituents of the S&P Composite 1500 Energy Index during 2012-2019. Pre- and post-oil 2014 crisis data split captures falling prices in 2014- 2015. The system is benchmarked against the buy-and-hold model. Despite falling prices, trades based on implementing Ichimoku continued to increase, with profitable opportunities. Most buying/selling signals took place outside of the strengthening of bullish/bearish trends. Findings suggest that speculators can benefit from the Ichimoku Cloud in analyzing energy stock price movements. Further, it can reduce susceptibility to changes in energy prices. The strength of the trend in place serves as an extra layer to enhance investment decisions.

Energy markets have been grabbing global headlines with terms such as decoupling, decarbonization, and energy policy. This was noted where the energy market has traditionally been coupled with U.S. GDP growth. During the 2014- 2016 period, oil prices lost more than two-thirds of their value. With prices continuing to roam around 40-50% of their 2011-2014 values, various oil-revenue dependent economies suffered significant drops in consumption and investments (World Bank, 2018). Oil price fluctuations resulted in volatile economic activity that led various economies to adopt more stringent policies, including reforms to reduce reliance on oil. This resulted in more prudent investors when making investment decisions related to energy commodities and equities. To add salt to injury, globalization has increased cross market interdependence. 

Energy market dynamics are also evolving with the U.S. Energy Information Administration predicting electric power sector to consume more energy than any other sectors, with renewable energy consumption growth being the fastest among other fuels. With subsidies for clean energy from climate-conscious governments and falling solar and wind power costs, renewable energy sources are expected to provide over ten per cent of global electricity over 2017-2022. Uncertainty in financial markets complicates the choice between fundamental analysis and/or technical analysis techniques for investors and traders. Although abundant research on technical analysis exists, there is a lack of focus on the market under study and the use of trend-based rules in the application of the Ichimoku Cloud.

The Ichimoku Cloud can be traced back to Goichi Hosoda, a journalist using the pseudonym Ichimoku Sanjin who combined moving averages with candlestick charts with aim of improving the robustness of his technical analysis. In 1996, Hidenobu Sasaki revised Goichi’s model and published Ichimoku Kinko Studies. Sasaki’s work forms the current framework underlying the Cloud chart analysis. Voted the best technical analysis book in the Nikkei newspaper for nine years consecutively, this method is still considered as one of the most popular approaches to technical analysis financial tools used in Japan and globally. The Ichimoku Cloud primarily consists of five components, namely the conversion line (Tenkan-sen), the base line (Kijun-sen), the leading Span A (Senkou Span A ), leading Span B (Senkou Span B), and the lagging span (Chikou Span).  See Gurrib, Kamalov & Elshareif (2021) for a review of the Ichimoku model.      

This is the first study to investigate the use of Ichimoku Cloud as a trading system for leading U.S. energy stocks. Our analysis is the first to provide insights into whether there are shared characteristics in the performance of energy-based companies, using the Ichimoku Cloud. This paper contributes to the existing literature by comparing the results from the Ichimoku Cloud trading system with a buy-and-hold strategy. The performance of the indicator is measured using Sharpe and Sortino ratios, capturing both total and downside risk. Further, we look at the ability of the technical indicator to provide trading signals, by complementing the analysis with the existence of trends and the strength of the trend in place.

Kumo (Japanese term for cloud) indicates probable future support and resistance levels. The top and the bottom of the Kumo indicate the first level and the second levels of support when the price is above the Kumo. Similarly, the bottom and the top of the Kumo indicate the first and second level of resistance when the price is below the Kumo. A price above (below) the Kumo indicates a bullish (bearish) trend, while price within the Kumo indicates a potentially trendless or rangebound situation. The thickness of the cloud shows the level of historical volatility, as well as the strength of support or resistance.     

The indicator provided at least 800 days with a minimum of one long or short position over a possible 1735 trading days. To better understand the effects of the drop in energy prices on the buying and selling opportunities the entire sample was divided into three periods around the 2014–2015 price drops. Trades increased despite the fall in energy stock prices. The indicator resulted in profits when energy stock prices declined.  Performance-wise, all stocks had total risk values below 15% with Sharpe ranging from 0.3 to 0.53. The Ichimoku Cloud performed better than the buy-and-hold strategy, where the latter produced negative returns for four energy stocks, resulting in negative excess return per unit of risk. Buying (selling) during a strengthening bullish (bearish) is commonly advocated as rational decisions. Our indicator produced several buying signals during a bullish period, with various buy/sell signals occurring outside of strengthening trends. 

Policy implications concern mainly speculators’ role in energy equity and commodity markets. Our findings indicate that the use of the Ichimoku Cloud can provide a profitable end results even during periods of significant oil price drops. Our insights help U.S. regulatory bodies like the Securities Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) better understand the profitability of energy traders during the declining markets. This is also useful for financial regulators such as the Emirates Securities & Commodities Authority in the UAE, who monitors and regulates the nation’s financial markets, namely the Dubai Financial Market (DFM), Abu Dhabi Securities Exchange (ADX), and the Dubai Gold & Commodities Exchange (DGCX). 

While the issue whether speculators are price destabilizers is beyond the scope of this study, our findings suggest that oil price drops are passed from commodity markets to energy stocks, resulting in oil companies being affected negatively. However, the losses for speculators who are skilled in the use of technical analysis indicators such as the Ichimoku Cloud are mitigated. Alternatively stated, financialization provides some benefits to commodity speculators who have access to energy stocks. Future research with alternative trading frequencies - a higher (say intraday trading) and lower (say weekly) frequency - is recommended. Furthermore, future analysis can accommodate trading opportunities during weakening trends in addition to strengthening ones. 

Disclaimer: The findings are applicable to both the period and specific markets under study, and do not constitute advice from the author or university. Past performance isn’t an indicator of future performance. 

Ikhlaas Gurrib is an Associate Professor (Finance), Faculty of Management, Canadian University Dubai

Firuz Kamalov is an Associate Professor (Mathematics), Faculty of Engineering, Applied Sciences & Technology, Canadian University Dubai

Elgilani Elshareif is a Professor (Finance), Faculty of Management, Canadian University Dubai

Citation:

Gurrib, I., Kamalov, F., Elshareif, E. (2021). Can the leading us energy stock prices be predicted using the Ichimoku cloud? International Journal of Energy Economics and Policy, 11(1), 41–51. doi.org/10.32479/ijeep.10260 Scopus (Q2)

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