USDJPY Short: A Case Study (Plus Why I’m Bearish on Oil and Metals)
Before I get into this week’s analysis, I’d like to show you an email I sent out to members of our Elite program on Tuesday, October 1st.
In that email, I talked about a USDJPY trade setup (the U.S. dollar versus the Japanese yen). I wanted to show you the double top pattern that suggested this pair was headed lower. Plus there was a huge key reversal where the market made a new high and then closed on the low of the day.
Those two things together suggested the sellers were in control and so I recommended selling USDJPY at 107.61.
Now here’s USDJPY on a weekly chart (the chart in that email was a daily chart).
Note how the price headed lower over the ensuing weeks, months and years after that early double top had formed. That’s because a double top price pattern is a reversal and it looks just like the letter M. The market goes to an all-time new high, backs off, then retests the high before cutting through the neckline is drawn across the entire pattern.
Once the neckline is broken, we know a double top has been completed and a reversal is highly likely.
In addition to that double top, USDJPY also traced out a head and shoulders which is just like it sounds like with a head (the double top in this case) plus a shoulder on each side. Together this entire price pattern indicated USDKPY was going lower.
USDJPY has in fact dropped from a peak at 126 to under 107 in about five years.
This pair has also formed a descending triangle since that head and shoulders. Each high is lower than the last and they’re all connected by a horizontal low in the 104 area. If you look at each high, they all had at least one key reversal which tells us the sellers were in charge by the end of the week.
And that means each rally has provided a good opportunity to get short, which is what I did last week because of the similarity to previous highs.
I expect USDJPY to revisit the earlier lows at 104 and perhaps drop to 100 at some point after that.
So here’s how USDJPY looks right now on a daily chart:
This chart is very instructive because sometimes it's difficult to sort out which is the guiding pattern for future price behavior. For example, it looks like we have a bullish double bottom but even though the price passed through the neckline there was no follow-through.
I didn’t bite on that double bottom for another reason: the huge double top within the overall downtrend that’s been in force since 2015.
That’s why I feel it’s very instructive to keep an eye on the longer-term patterns so we can sort out which patterns are real and which are not.
Now for the main analysis this week, starting with the U.S. Dollar Index (USDI).
USDI tracks the U.S dollar against half a dozen major currencies and as we can see, it’s been heading higher.
As with USDJPY, there’s a bit of a conflict where we see what could be a reversal pattern forming to push USDI down with some bearish key reversals in recent weeks. Ordinarily, key reversals like this would alert me to consider shorting the dollar.
But USDI has adhered steadfastly to its long-term uptrend line (and a shorter-term one) too. This suggests any price drop should be short-lived and a minor move at best. I expect USDI will continue to respect the uptrend line and go higher.
Now it’s possible the current level could turn out to be a huge reversal area. USDI is at a major resistance area and that’s something to watch. However, USDI has shrugged off these attempted reversals several times in recent history and kept powering up.
Unless the trendline is breached significantly, I think we can expect that behavior to continue.
As always, the market will tell us what’s going to happen next if we’re patient and keep an open mind about the possibilities.
With that in mind, we can review EURUSD (the Euro against the dollar) and its descent from 1.70 to less than 1.10.
Right now we have an intermediate price pattern in the form of this head and shoulders, the neckline of which was penetrated some time ago. Then last week we had a bullish key reversal to suggest a reversal to the upside.
While there may be a rally, I don’t think there’s enough here to deliver a significant turnaround in EURUSD. This pair is still in a downtrend as the price remains within a long-term channel. At best we’ll see a minor rally or a sideways slide within the channel.
In this chart, I'm looking at GBPNZD (the British pound versus New Zealand dollar). This pair just hit a pocket of resistance consistent with this major resistance area between the 2.00 – 2.05 price level.
However, I feel GBPNZD will resolve this to the upside thanks to patterns that formed several years ago, such as the double bottom and rounding bottom after that.
We’d also had a double bottom right around the 1.80 – 1.82 price level. And while I'm not ruling out that we could see a drop to the downside, ultimately I do feel GBPNZD will break higher down the road.
Remember that we do have a Brexit event coming at the end of the month and perhaps that will be the catalyst. In the meantime, I’m on the sidelines watching for an opportunity.
Now let’s like at U.S. light crude oil because of the way it’s traded in spite of media hype over news events. It’s a great example of why I don’t trade on the news.
Light crude oil has dropped from $105 several years ago to its current level of around $53. So it’s been in a significant downtrend for quite some time. It even traced out a double top around the 75 areas along the way — when it cleaned that neckline, it dropped, retested the neckline, and has begun to slide once again.
But you probably recall that the Iranians bombed the Saudi oil refineries to take out 5% of the world's oil production. Crude oil prices jumped $10, but if you were trading on the news or made a knee jerk emotional response, you would have very quickly been a loser if you thought higher prices were on the way. I expect oil’s bearish trend to continue and we’ll probably see the price under $40 in the not too distant future.
This is a good example where a fundamental driver could not sustain a market that was ultimately a dictated by bearish price behavior over weeks, months, and years. This is why just understanding and observing price is the best way to make money in the markets.
Now let’s look at the precious metals, starting with XAGUSD (spot silver) on a monthly chart:
We’ve seen very negative price behavior in silver where in the last month it rose to a high above the $19 area and then closed around $17 with a huge key reversal near a major resistance area.
Now we’re at a crossroads and I’m going to wait and see what happens next. If XAGUSD can hold, this very negative behavior will have been a fakeout.
However, I think it’s much more likely that we’ll see bearish price action as the primary guiding pattern is the long-term double top. Once silver dropped below the neckline at $26, there’s been no looking back.
That’s why the recent spike was probably just a rally within a long-term bear market.
This view is borne out on the weekly chart too:
Silver closed very badly as it tried to rally past resistance. Even though silver went to multi-year new highs, the sellers were in control by the end of the week. Now we have what looks like a double top price pattern combined with key reversals.
This is a very negative price action and it will be difficult for the market to take off after that.
However, bear in mind no market goes straight down. I think we’ll see considerable sideways action as silver works its way lower.
So how about XAUSUD (spot gold)?
This weekly chart is causing me a great deal of conflict. On one hand I see this a double bottom as part of an inverted head and shoulders which is very bullish since the neckline was penetrated. However, there’s been a number of reversals around the $1,550 – $1,555 area. We had another reversal in that same neighborhood to form a potential short-term double top.
Then we had a reversal in the recent week where gold made a new low around $1,460. This is an area I thought would be supportive and we did recover very smartly there.
But I'm not ready to say what the outcome of this market is going to be one way or another. Ultimately, I'm going to defer to the market and wait things out for now.
So if we see XAUUSD prices are recovering and we see another trajectory toward the highs, then it's likely the bull trend is intact. But if prices fall instead and start drifting, then I would be looking to see lower prices for gold.
When things look this indecisive, just step aside and see what the market does. Stay on the sidelines and see what happens going forward.
Gold’s daily chart looks a bit more bearish, though.
We can see a double top at the $1,555 area, plus it seems to be part of a head and shoulders, which is even more bearish. XAUUSD has rallied over the last few days, but then made an inside bar where the new bar’s high and low is entirely inside the earlier bar.
An inside bar represents a storage of energy which will be released at some point in the near future. Given the double top and head and shoulders, I think that release is most likely to be down.
That’s why I’m tempted to place a sell stop somewhere underneath the recent lows, but not yet. I think there will be a better opportunity in the not too distant future.
In this chart, I'm looking at the S&P 500, the major U.S. stock index.
Last October when I saw the inside day bar I’ve highlighted here, I predicted a major reversal due to the ‘stored energy’ nature of inside bars.
When you see an inside bar at the top of a huge rally and also in the neighborhood of another resistance area, plus what looked to be a double top pattern emerging, this was a great opportunity to go short.
I went to town buying an index puts and puts on the FAANG stocks and made all kinds of money during the 20% drop in the indexes.
More recently I saw the same kind of inside bar in conjunction with a double top and key reversals, but I was more hesitant as to whether that would represent the same kind of opportunity.
That’s because there have been bullish key reversals too which are at or along an ascending trendline. I predicted that any drop this time wouldn’t last long. And that's exactly what we've seen.
So going forward, there looks to be good support for the S&P 500 and you're not going to get a whole lot of mileage shorting the market right now. The path of least resistance still looks to be up even if we see a fair amount of sideways action in the near term.
And that’s it for this week!
To summarize, I’m bullish on the U.S. dollar, GBPNZD and probably the U.S. stock market indexes right now. I’m bearish on USDJPY, crude oil, and precious metals.
I wish you a very healthy and prosperous trading week.