Yen Crossing Opportunities

Since the summer of 1998, Japan’s deflationary economic environment has kept the Japanese Yen (JPY) strong against all other major currencies. The strong Yen had a positive effect for Japanese capital owners. They imported products at relatively low prices (in Yen terms) and as the Yen strengthened, it also increased their wealth in terms of other currencies. The strength of the currency was one of the main reasons why Japan government bond buyers were willing to accept such low yields.  On the other hand, the strong Yen was a long term destructive force for industry in Japan.  Japan’s export companies were confronted with uncompetitive prices overseas for their products.

About two years ago, the Japanese government decided (under guidance of Prime Minister Shinzo Abe) to stimulate the economy through an aggressive monetary-easing policy in order to support Japan’s competitiveness (popularly labeled “Abenomics”). This monetary expansion was intended to lead Japan out of the deflationary cycle by weakening the Yen and, thus, creating a competitive advantage — so-called “healthy inflation”. As a direct consequence of Abenomics, exporters have generated better sales and enjoyed higher profit margins due to the falling prices of their products for foreign customers.

Since the implementation of Abenomics, the JPY has been devalued heavily.  Against the EUR, it dropped by 55% and against the USD, it dropped by about 35%. On Forex price charts, the JPY devaluation looks like a very strong and smooth uptrend against other currencies for the last two years.  During this uptrend, moving average crosses have presented a number of excellent low risk trading opportunities.  The charts indicate the possibility of a change now, however, and the question on everyone’s mind is, “What happens in the next two years?”

The Uptrend Continues?

While the previous trend for a strong Yen lasted 16-years, the Bank of Japan’s (their central bank) monetary-easing policy produced a definite change in direction in the last two years. You can see the results shown in the weekly charts (see below): All 4 charts show a very strong and smooth uptrend. For nearly two years, the moving averages have paralleled each other with 8, 21, 40 and 50 EMAs neatly stacked on top of each other. Price has respected the 21MA as a major support area on multiple occasions as well as a sign of a very strong trend.  This situation has also created a profitable playground for trend-following strategies.

The burning question is, are these extraordinary trends going to continue for another two years? It is possible, but from a charting perspective, it is not so likely. Every strong & smooth trend encounters a more pronounced pullback at some point before the trend regains strength again. Pullbacks of 50-60% are normal & healthy in a trending market and that may happen for the Yen soon.

Detecting Turning Points in Trends

I am a strong advocate of trading with the trend. There are, however, two types—well-established trends and early trends. Although trading in established trends is my preference, trading early trend reversals can be very profitable. This means that although there is a uptrend in the higher timeframe (such as the weekly chart here), you can find a good downtrend in lower timeframe charts — eg 15, 60 or 240 min, which then leads the way to an overall weekly pullback short.

What are the beginning signs of a pullback?  The line in the sand is the 21EMA- the most important moving average currently. Another key sign would be when price no longer respects the 21 EMA. As seen above, the EURJPY seems to play (followed by the USDJPY) a leading role. The blue line (21EMA) has been broken for the first time in two years by a candle close (see last red bar before the current one on the chart below). Although small, this is a noticeable event that might indicate an early trend reversal. To further investigate, traders have to drill down to lower timeframes that should give clues to support this early suspicion.

Should this early indication be proven right, a good number of Busted patterns (setups for my system 1) should occur. The busted breakout pattern gives, apart from situations in mature trends, a good number of opportunities in beginning trends. Now, the market might be in the right psychological mood to do exactly that and turn around.

Early Trend Reversal Indicator – Busted Breakouts

Busted patterns are specific chart formations that profit from breakout failures in which both the long trader/investor is trapped in a losing trade while, at the same time, the short trader/investor is trapped out of a good trade. This situation of a “double trap” leaves psychological footprints in the market and offers great low-risk trading ideas at a specific price level.

Let’s have a look at the 240 and 15min charts of the EURJPY:

EURJPY 240 min chart

The triple high (240min) prices have moved down in a decisive way. Consequently, the MAs have come into correct order indicating an early downtrend. The correct chronological order of moving averages (8<21<50MA) in 240min timeframes is a requirement needed for a Busted pattern to be tradable in the 15min chart (see below).

15 min chart

Indicated by the red horizontal lines, three Short Busted pattern trades have developed consecutively. Very often a Busted pattern is followed by another one in the same pair and timeframe or that of another pair and timeframe. Since Weekly chart is in an uptrend, I would qualify it as the beginning stages of trend reversals – all of these setups were tradable as you can see by the subsequent red candles down to a lower level.   Busted patterns come in swarms (just like the giant squids) and there might be others coming in other Yen crosses. On May 16th, a long-stretch busted breakout pattern (which is difficult-to-trade) developed in the USDJPY (15min).

For the time being, both EURJPY and USDJPY are in early reversal mode, with GBPJPY, NZDJPY and other JPY pairs potentially following. Therefore, additional trading opportunities with the Busted or other trend-following systems might develop.

How Far a Pullback?

The EURJPY chart offers room for a 25% correction until the next decent support level at 130. In this case, several good trend-following opportunities should occur on the 5, 15, 60 and 240min timeframes.

EURJPY Weekly

We should now be able to observe how things will unfold. There is no certainty in the capital markets, but some psychological constellations offer a higher probability than others. I think there is a good chance that JPY will strengthen across all Yen pairs in the next few weeks. Should, however, price break above the May 12-16 weekly red bar, a continuation of the uptrend would be then most likely.

Please note that while early trend reversal pattern trades tend to have a higher expectancy, they also have lower winning probabilities.  Once they run, however, trades with a new trend may deliver a very nice reward over time. Decide for yourself if you prefer trading/investing in well-established trends or trend reversals—trying to trade both kinds of moves can be very challenging for newer traders. As a general comment, trading with a clear trend is better to start with; however, trend reversals should not be ignored.

I hope this helps you understand some ways to think about trends reversals and provided some insight for identifying some good low risk trading opportunities.