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EURJPY: Time To Buy?

November 3, 2010 Leave a comment Go to comments

The EURJPY is nearly complete in carving out a bullish multi-month Inverse head-and-shoulders pattern. If the recent pivot low of 111.51 holds ―then it is likely the right shoulder is in place, and a significant rally could already be underway.

Adding further support on the 'TA' front is today's breach of an imposing long-term downtrend line extending back to mid-2008, which has capped rallies on several occasions. The most recent failure came less than a month ago. Today's daily close above this line is a good start, but a weekly close above will be even more convincing.

A major factor likely to impact the performance of not only the EURJPY, but JPY crosses in general, is the extreme bullish sentiment accompanying the Yen's move. Dollar bearishness is generally high versus all of its G7 counterparts, but it is most extreme when compared to the Yen; this makes sense considering the Yen is flirting with its all-time high. Upon looking at Sentimentrader.com's "Public Opinion" model, a composite indicator of various sentiment metrics, we can see the bullish JPY reading of 77.55 is considerably higher than current levels in other G7 currencies — EUR: 58, GBP: 49.17, CAD: 56.43, CHF: 67.65. (There is no data for AUD, which might rival the JPY reading, as it is at a 28 year high.)

Even if the Dollar's decline continues to persist, I hold the view that the Yen has reached a point of bullish saturation; whereby there aren't enough participants left to jump on the bandwagon in order to sustain the current trend's momentum, thus causing it to under-perform relative to other currencies. (On a micro note: In the past few days we have begun to see the JPY undeperformance set in, despite continued Dollar weakness.) On the flip side, a Dollar rally, an event which I think is just around the bend, is likely to cause the overcrowded JPY boat to capsize, sending the JPY down at a faster rate than the other majors. Also, there is the downside risk of more BOJ intervention, which will provide further underpinnings for bullish trades in JPY crosses.


Eurjpy

There does exist an alternate scenario – a bearish rising wedge could take shape. This formation, however, will require another 2-4 weeks of development before becoming a mature pattern. The EURJPY will need to rally up towards a level currently labeled as the neckline (~116) of the before mentioned inverse H&S pattern. At which time price would need to turn lower, eventually undercutting the rising trend-line extending back to the September low.


Eurjpy triangle

*Interesting To Note: During the summer months the EURJPY carved out a smaller but similar chart configuration as the one currently unfolding. The outcome then: A fake-out breakout above the neckline, subsequently leading to a breakdown from a triangle pattern; which carried price down to fresh lows. (As I've noted in prior post, head-and-shoulder patterns and triangles resemble one another during the formation process.) I don't, however, think it is likely we repeat this past summer's events, but it is worth taking into consideration.


Eurjpy summer

How To Play The Set-Up:

At this time, given the current chart-scape, initiating a small long position with a stop below the 111.51 pivot provides a favorable risk/reward profile in the event that a breakout above the neckline occurs. If in fact price does breakout above the neckline, then a full position can be established with a target of 1.25-1.28. This target has been determined by adding the difference between the high and low of the pattern, ~1000 pips, to the neckline, ~116.

Furthermore, Head-and-shoulder patterns and their inverted brethren have a tendency to retrace back to the origination of the price move immediately proceeding the H&S formationor in this case Inverted H&S. In order to get back to the point where the prior move down originated from, a rally up to the 1.25-1.28 area has to take place.

Interestingly, for those fib buffs out there, the 61.8% re-tracement of the October 2009 – August 2010 leg lower is 125.76; right in the thick of the projected target zone.

If the second scenario comes to fruition, the rising wedge, then due to the upward sloping trend-line from the September low ― long positions initiated off the I-H&S set-up can be exited with limited losses, if any at all. After exiting this position, a play on the short-side will be the next move with the target set below the September low of 105.41. Again, similarly to the I-H&S set-up, the triangle's price target is determined by subtracting the height of the pattern (~1000 pips) from the breakdown price, providing a target of ~105, depending on the exact point of the breakdown.

In conclusion, EURJPY is offering an excellent opportunity to enter a trade with positive expectancy and a clear backstop for assessing risk. Furthermore, if the stop is triggered on the long position, there is a high likely-hood that the stop, in of itself, becomes an opportunity to switch gears and profit from the short-side. I will continue to post updates regarding this trade as the action unfolds.

 

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Categories: Commodities and Rates
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