The USD/JPY Breakout Stalls At Target

06/22/07 08:57:21 AM

by David Penn

Bulls exit as a swing rule projection from a recent breakout in the greenback/yen is reached.

Security: USDJPY
Position: N/A

The US dollar–Japanese yen pair has been in an uptrend since March 2007. That month, the USD/JPY finished a sharp correction brought on by a panic over the health of the carry trade.

If the concerns over the carry trade caused the selloff, then the resulting rally, which has more than retraced the entire correction, suggests that the carry trade is alive and well. The carry trade refers to the purchase of higher-interest rate currencies (in this case, the US dollar) and the sale (or borrowing) of lower-interest rate currencies (in this case, the yen). Speculators take advantage of the disparity in interest rates to secure low-cost financing from one source and higher rates of return from another.

When a market is in an uptrend, the goal of short-term traders is to trade the swings. This means buying the dips or the breakouts to new highs. This can be one and the same, as will be the case in the example provided in Figure 1. One of my favorite sayings about swing trading comes from Oliver Velez Jr. of Pristine.com, who told an audience of traders: "Your mission as a trader is not to buy some of the dips, not to buy most of the dips, but to buy all of the dips. The only question is when."

Japanese candlesticks provide one way for traders to "know when." By spotting basic candlestick reversal patterns at potential support levels during corrections in a trend, traders can find excellent low-cost entries while taking advantage of the power of the underlying trend to move prices in the anticipated direction.

FIGURE 1: US DOLLAR/JAPANESE YEN (USD/JPY), DAILY. The end of this pullback in the uptrend of the USDJPY was signaled by a bullish engulfing pattern. The lowermost horizontal blue line represents the breakout resistance level and the vertical blue line represents the price target based on a swing rule projection from the four-day correction. The higher horizontal blue line represents the current support level for traders who did not exit when the target was reached three days after the breakout.

Graphic provided by: eSignal.

Consider the pullback in the USD/JPY in early June. The market rallied into the month but stalled soon afterward and began a four-day correction lower. On the fifth day, a sizable bullish engulfing pattern appeared suggesting that the correction might be over.

The bullish engulfing pattern is one in which a single bullish candlestick line appears at the end of a downtrend with a high and a low that both exceed that of the previous bearish line (or lines). In order for the pattern to provide a reliable signal, the pattern should be confirmed by some additional technical factor, such as support.

Defined as the place where bearish momentum grew weak, support for this bullish engulfing pattern comes from the long lower candlestick shadow from late May. This, along with the lows of the bullish engulfing candlestick itself, provides a clear "Get Out!" level for traders looking to buy the dip in the USD/JPY uptrend by buying the opening session following the close of the engulfing session.

Another option would be to buy any breakout to a new high. Two dojis follow the bullish engulfing day, and after that USD/JPY surges higher, taking out the highs set on June 1. A trader could buy the close of that breakout and use the level of the breakout as a support point.

What sort of profit target might a trader buying this breakout look for? Since there are no previous peaks to use at price targets, another option is the swing rule. The swing rule calls for traders to measure the distance from a trough low to the top, and to add that amount to the value at the top. In the case of the early June correction in the USD/JPY, we get a swing that projects to 123.51. A trader buying the breakout session's close would be long at 122.59, setting the stage for a 90-odd pip trade. With a stop at the level of the breakout, the trade has roughly 45 pips of risk. A 2-to-1 reward/risk ratio makes this breakout worth buying.

Three days after the breakout, the USD/JPY closes at 123.61, a few pips beyond the target. And as the spinning tops that have developed since attest, the stalled rally appears to provide an excellent opportunity for traders to take profits.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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The USD/JPY Breakout Stalls At Target

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