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  1. Home
  2. / Investing
  3. / Financial Services

The Technical Risks of USD-JPY

Symmetrical triangle breakouts trap many traders.
By TONI TURNER Jan 14, 2014 | 03:30 PM EST
Stocks quotes in this article: MFG

I read a number of reports heading into the end of last year that focused upon the bullish Japanese markets. Many cited the rally in the U.S. dollar-Swiss franc cross (USD-JPY) as evidence of the bulls at play. As the USD-JPY moves higher, the Japanese yen is weakening against the U.S. dollar. This is bullish for Japanese exporters and can indeed push shares in many Japanese companies even higher. The primary technical pattern many cited as evidence of this bullish bias was the upside breakout from a symmetrical triangle on the weekly chart of the USD-JPY (as shown below).

Symmetrical triangle breakouts, however, trap many traders. They are fickle breakouts, full of false starts and false hope. The general consensus in the world of technical trading is that a symmetrical triangle is a continuation strategy; it's not -- at least, not always. I even recall Alan Farley sharing a strategy of his with me many years ago that he called a "Hell's Triangle," which is a reversal strategy based on the triangle.

If what I'm saying is true -- and trust me, it is! -- then how do you know which symmetrical triangles will continue the trend, which will reverse and which will continue it only briefly and then reverse? While many were talking about the USD-JPY symmetrical as a major continuation play, I took the contrarian approach and felt that the USD-JPY fell into the last category instead -- that is, offering initial hope with the strong potential for a slap in the face. As such, several weeks ago in the Columnist Conversation, I wrote about the bull trap that was developing in the currency pair. Over the past two weeks, the market has felt that slap. While the pair found initial support yesterday for those such as myself who were swing-trading the short side, I still feel that the bulls should continue to use caution, because an even greater weekly correction may easily be on the horizon.

One thing that stands out to me when I look at the weekly chart of the USD-JPY is that while it does have a major symmetrical triangle compared to the rally that took place throughout the final quarter of 2012 and into the first two quarters of 2013, the triangle itself was rather minor. In other words, it looks a lot like a hazard flag -- that is, a small flag on a long pole. When these types of triangles break to the upside, they typically make a nice run to the prior high. Often, as in the USD-JPY, they will hit a higher high. This creates what is known as a bull trap, because many bulls will view this break of resistance as a bullish indicator when instead it tends to merely trap them and is often followed by a sharp corrective move! This was what happened so far this month.

Another trait that caught my eye on the USD-JPY was that the early 2013 rally was not the first rally in the pair since it bottomed on the weekly and monthly charts. It was the second. The first rally took place in the first quarter of 2012. That meant that the second rally into 2013 was substantially larger than the first, even though the corrective periods (shown as A and B on the weekly chart) were about the same. While most trading range breakouts have the potential for a measured move whereby the breakout move will be as strong as the wave of buying into the correction (such as a triangle), if the second move within a trend is much stronger than the first, then the odds are higher that the third wave of buying will be more on par with the first wave. In the chart below, notice that the measured move from wave 1 hit with wave 3 at the end of December. This strengthens the odds for a longer weekly to monthly correction.

Yesterday in the Columnist Conversation I made a note of the daily support that was hitting in the USD-JPY. This is giving us a strong reaction off that support level intraday today, but, as you may have already guessed, I am not buying into it as a major bullish move. I feel that at the current levels, the bullish focus should be on the short-term moves off support such as this, using caution on the longer-term outlook and watching for reversal strategies of highs using the 60- to 90-minute charts to prevent giving back gains on the stronger flushes to the downside that are common at these levels. We may see another higher daily high or two at this zone, the upside risk due to the weekly and monthly price action remains high.

For those who do wish to continue to play the upside or are looking at hedges against short plays, I suggest taking a look at Mizuho Financial Group (MFG). Mizuho is a Japan-based bank holding company and is forming a stronger version of a bullish symmetrical triangle on its monthly time frame.

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At the time of publication, Hansen had no positions in any securities mentioned.

TAGS: Currencies | Markets | Financial Services | Investing

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