The GBPUSD spot fx (cable) rate has made steady gains of late and looks as though it may be gearing up for a possible breakout to the upside. What I like about this is that it also appears to have formed a pattern within a pattern, when this occurs moves can sometimes be dynamic.
The pattern within the pattern is as follows:
1) The larger pattern is the Weekly 'Descending Expanding Triangle' pattern formed over the past 15 months, which may actually be part of a big double-bottom pattern. The actual pattern bears a strong resemblance to the bullish pattern formed on the AUDUSD over the past year, which was covered in detail in the 17 Sept post which can be seen by clicking here. An illustration of the ideal formation can be seen here:
2) The secondary pattern, which has formed as part of the breakout of the above pattern is a Cup + Handle on the daily chart. Cup + Handle patterns do not necessarily have the greatest success record with regard to pattern reliability, however what I like about them is that they offer excellent risk/reward ratios. The stop level is usually quite close to entry, whereas the upside (if the pattern is successful) is often relatively large. The following illustration highlights an idealised Cup + Handle pattern.
Put the two together, and there is potential for a decent move if this can hold over 1.6000 on a sustained basis. The chart below shows these pattern on the GBPUSD.
There are one or two reservations with this: Firstly and principally the weekly 'Descending Expanding Triangle' pattern does not follow in the wake of a large trend, the prior move is short trend which itself is a reaction off a low following a very large decline. Typically these patterns follow strong sustained trends as per the AUDUSD example. I also prefer these patterns to have largely tracked along the upper line at fairly even spacing, the GBPUSD pattern has touched (or nearly touched) the upper line on four occasions prior to breaking out, however the gap between the third and fourth was very large. -- Perhaps I am being picky, ideal patterns are very rare, however I feel these points are worthy of a mention. The Cup + Handle pattern does look textbook though, and as long as this can sustain itself over 1.6000 (allow a spike or two lower), then this favours a move to around 1.6700.
A quick note re: the SP500: Despite a strong move at the open it once again failed to maintain and hold a move higher, and it also failed to maintain an afternoon push lower, once again closing slap-bang in the middle of last weeks daily closing 1182-1186 range. - dull, dull, dull.
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.
I have mentioned on many occasions how I see AUDUSD FX as a strong barometer of Risk-on versus Risk-off. - Over the course of this week the AUDUSD has been trying to break over key Resistance around .9400. It made a push earlier this week, however it was not able to sustain this, once again however it is making a push over .9400, currently it stands at 9440, the high of the day so far was .9469. If this break can be maintained then the odds grow strong that the AUDUSD is likely to make a meaningful push higher over the next few months. IF this were to happen, it is likely to suggest that investors are once again looking to adopt greater levels of risk, which clearly should have bullish implications for US equities. - The counter argument, would be that a failure here would at a minimum suggest further consolidation of the range of the past few months, with the risk of a much deeper correction. - My favoured view is that an break higher is coming, though I am not certain whether this is it, the next next couple of trading days should produce some clarity on this.
To elaborate on what I am looking at. The pattern I am seeing on the AUDUSD chart is a Right-Angled/Descending Expanding Triangle. (Essentially this is a Descending Expanding Triangle where the top line is Horizontal or near Horizontal). Successful breakouts of these patterns tend to lead to strong Bullish moves. The insert below shows the typical set-up. [Note: On shorter term charts I call this a 'Slingshot Formation', as the behaviour reminds me of a slingshot, whereby the strong pullback will add impetus to the eventual breakout, leading to a strong and dynamic move.]
The Weekly AUDUSD FX chart below shows the large pattern I am referring too, which has formed over the past 10 months.
Below I have posted some prior examples of this pattern. Note : these patterns are quite rare, they are also prone to false breakouts as per the first example below which shows the US 10 year Note Future through 2009 - 2010. The above chart bears quite a strong similarity to this particular example, thus if it were to repeat the similarity it could mean we may see a further period of consolidation below the upper line for several more weeks prior to eventually breaking out.
The next two examples are from the Continuation Bund Future in 1993 and the Sp500 Future from 2005.
One other observation from the AUDUSD chart is that this pattern may be part of a much larger Multi-Year 'Cup and Handle' pattern which has been forming over the past 10 years. I am always a touch reticent to label patterns over such large periods, however since this may have strong Bullish consequences for the AUDUSD over the long-term I do think it is worth displaying.
Today's close is quite crucial, since a close well over .9400 could confirm a Daily and Weekly break of the key resistance. However as per the first example above, a reversal and poor close could mean further consolidation lays ahead.
MIDDAY Update - Markets have turned around sharply, the AUDUSD has slipped back sharply to 0.9400. If this sharp intra-day correction is maintained, and we close around here or lower, it brings the 'False Break' scenario into play.
Also I have noticed the SP500 may be forming a rare '3 Peaks and a Domed House' pattern on the Short-term Chart. - I have attached the chart below, together with a copy of the Idealised '3 Peaks' pattern. This may lead to a correction down towards the start of the pattern around 1090 over the next few days.
Earlier this week I was discussing crowd psychology and its effect on price action. I will not bore you with details of the conversation, however it did lead to me recalling one of my favourite scenes from 'The Life of Brian' which easily makes it into my 'Top 5 movies of all time'. The scene is where the reluctant Brian is addressing the mass crowd standing outside his house: it goes as follows:
Brian: Look, you've got it all wrong! You don't need to follow me, you don't need to follow anybody! You've got to think for yourselves! You're all individuals!
The Crowd (in unison): Yes! We're all individuals!
Brian: You're all different!
The Crowd (in unison): Yes, we are all different!
Man in Crowd: I'm not.
Here is the scene -- Pure class.....
Have a great weekend... Wherever you are...........
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