EURJPY FX

With markets likely to track time this week ahead of next week's slew of news. It is an opportunity to look at some other areas of interest within the wider markets. Today I will look at the EURJPY FX cross, as there may some interesting action occurring here.

The first chart is the multi-year weekly chart. Currently the major trend remains lower, however momentum is strongly divergent here; momentum as measured by the RSI and MACD on the recent 2010 low is well above the momentum levels recorded at the low of 2009. This does not mean a break-up through the declining trend-line or a trend change is due, direction is primary and momentum is secondary, however it is suggesting it is a reasonable possibility. In addition I want to emphasise the strong similarity between the price action and momentum developments over the past 2/3 years, and the period in the mid-1990s when this currency pair made a major low.

 
The weekly charts thus appears to offer some interesting possibilities. The daily chart below can add some further clues, though nothing decisive at this stage. The first thing to notice is the large Expanding/Broadening Triangle formed over the past five months. (See notes and illustration below regarding Broadening Formations - btw the example described refers to a broadening top but it is also valid as a broadening bottom, particularly in currencies where we are comparing two currencies, rather than an asset.)

 
John J.Murphy in his book 'Technical Analysis of the Financial Markets' (in my opinion - the Bible of Technical Analysis) shows a diagram of an idealised Broadening Formation. (See image above).Murphy goes on to say - "This situation represents a market that is out of control and unusually emotional. Because the pattern also represents an unusual amount of public participation, it most often occurs at major market tops (Bottoms). The expanding pattern, therefore, is usually a bearish(bullish) formation" . With regard to volume during the formation of the pattern Murphy says -“The volume pattern also differs in this formation.  In other triangular patterns, volume tends to diminish as the price swings tend to grow narrower.  Just the opposite happens in the broadening formation.  The volume tends to expand with the wider price swings.”

Coming back to the EURJPY we thus have a weekly set-up where the downside is still in charge, but strong corrective influences are at work. And a daily chart showing a strong reversal pattern, however within this pattern is still the possibility of one more dip lower, and/or the possibility, as with all patterns, that the patterns does not actually work. I would also like to add that the price is pushing against the downtrend, which adds some tension to the situation, a continued rejection of the downtrend would favour the dip lower scenario, whilst a sustained break of the downtrend, would be a signal that further strong gains may be in the pipeline.

Finally, the short-term chart also has an interesting little pattern. I show this on the 6-hour candle chart below. The pattern is a Sideways/Declining 'Expanding Wedge' , these can produce quite explosive upside moves. I do have some reservations about this particular example though; the slope of the upper line is more pronounced than I like to see in these patterns, typically I like the upper line to be close to horizontal or at least a gentle downward slope, however the proximity of the major downtrend line may be influencing this. I would also like to add that the trading signal to go long on a break of this pattern would be a move over 113.94 the last high in this pattern (however, it is worth bearing in mind that the major downtrend line intersects aroind 114.50), with a stop placed dependent on other factors. I would not suggest going long unless 113.94/114.00 occurs, particularly as very short-term, yesterday's price action produced a bearish '3 Black Crows' pattern, which may produce downside follow though in the next couple of days.

One final thing with regard to this trade. A look back at the weekly chart suggests to me that if the down-trend line is broken, then the upside potential could be very large and relatively rapid. This suggests to me a very good risk/reward trade. If the break-up were to occur without the low of the past 24 hours being broken, then we are talking about a long instigated at 114 with a stop at 112.40, and potential upside target of 140.00. The risk would be 160 points, the potential reward 2600 points = Risk reward ratio 16.25:1. And no carry cost.