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Completion of Trading Range in USDJPY

"The Yen has a tendency to trend, take a timeout, and then trend again" - Stanley Druckenmiller, 2015

Since the end of 2015 USDJPY has been forming a trading range between 115 and 125. This past week the currency pair closed below 115 with a breakout to the downside. Clearly, many market participants have been monitoring these levels in anticipation of a swift move out of the consolidation that lasted over a year. Accordingly, most of the initial move was absorbed this week. However, there is still some room for the pair to decline to the next level of support around 110.

Some technicians may argue that the consolidation resembles a Head and Shoulders pattern. While there is some reliability in pattern recognition, I believe it is more important to identify the meaning of a pattern. In other words, a Head and Shoulders arrangement is a sign of distribution often seen around price tops. In fact, USDJPY began forming a series of Lower-Highs and Lower-Lows on a weekly basis during late summer 2015 and into the end of 2015 which is indicative of price distribution. Understanding this behavior will better equip traders to position themselves appropriately for the most probable outcome of future events and in the direction of the dominant trend.

In the first chart below a clear range bound pattern can be seen with weekly bars. After USDJPY retested support around 117 in January 2015 it began to trend below that level until it formed a near-term pivot around 112. Depending on the technician, the measured move from the prior range could target either 105 or 109. Traders should watch for the price to form some support at either, or possibly both, of these levels and cover at least a portion of their short positions in USDJPY.


Additionally, the daily chart paints a similar picture. From the end of 2014 throughout all of 2015 a clearly defined range can be seen. However, support around 116-117 was broken on a closing basis this month. After trending lower for the first half of February 2015, USDJPY reached an oversold level as indicated by a Relative Strength Index (RSI) below 30. Consequently, some snap-back should be expected. Therefore, traders should watch for resistance at 116 which may correspond with a neutral RSI reading around 50. Although, after entering a short on a break of 116, a move up to 117 would be within a positive 1 standard deviation move based on recent price volatility. Additionally, 110 would represent a negative 3 standard deviation move, typically a level where it is prudent to begin “peeling off some contracts” as Tom Basso advised during an interview.

Ultimately, considering that the direction of the timeframe of greater magnitude (i.e. weekly) is trending down, any move up in the daily chart could be an opportunity to sell more USDJPY until the longer, dominant trend changes direction. Trading in the direction of the primary trend and analyzing multiple timeframes when building a position can help improve overall performance and better mitigate risk in your account.


Interestingly, the fall of the US dollar against the Yen comes shortly after the Bank of Japan (BOJ) issued its latest stance on monetary policy where it is targeting negative interest rates* in an effort to further devalue the Yen through forcing institutions to sell their Yen-denominated deposits and put the money elsewhere. In the end, there is only so much a central government can do when manipulating a market. The price will win out independent of any other force.

As always, please feel free to contact me with any comments or questions. Thanks for reading.

JD


*In effect, negative interest rates should theoretically reduce borrowing costs for businesses and households thereby providing more economic stimulus. However, rates below zero are an extreme form of monetary policy which is not a harbinger of good economic health. Also, from a fundamental perspective, the move to a Negative Interest Rate Policy (NIRP) by BOJ has caused some Yen-based carry trades to be unwound which may be strengthening the Yen in the short-term.  
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