Should You Be Focusing On The “Sexy Markets” That Are Dominated Headlines?
There are some very interesting trades setting up in the markets right now, but they’re not where most traders are looking first. In fact, the most popular markets are the ones to avoid … for now.
For example, we've seen giant moves in the stock market and gold in response to the biggest health crisis we've had in a century.
Here’s the NASDAQ, which dropped 30% from the top to the bottom:
Since then, it’s rallied 70% over the last month and now it’s anybody's guess as to where it’s going from here. The path of least resistance is still higher– there’s a recent bullish key reversal, for example.
However, I'm wary of going long here because this market has already rallied 70% and a reversal could be right around the corner. I like to identify trades as they're coming out of the gate. I like trades where the wind is at my back in the form of an excellent risk/reward ratio.
I’m not so confident that’s the case in the NASDAQ due to the spirited rally we’ve seen already.
That’s why I’ll be showing you other trades with better risk/reward prospects. Trades like that are how I've made all kinds of money in the last month or so.
Hopefully, you’ve managed to do the same. If not, keep reading to learn more about how I select trades with the best chance of delivering large gains with minimum risk.
But before I do that, let’s use spot gold (XAUUSD) as another example of what NOT to trade. Gold’s the other hugely volatile market lately, and I’m not keen on trading it right now:
Gold is at the apex of a reverse triangle pattern. It could break out to the upside and it could also reverse from here. For now, I'm simply drawing a structure and waiting for price action to dictate where the market goes.
Gold had a recent bullish key reversal (as with NASDAQ) which suggests the market is going higher. But just like with the NASDAQ, I’m leery of getting in right at the top, especially at a level where there’s already established resistance at the $1,750 level.
The risk/reward just isn’t good here.
If you go long, you’re at risk of a large drop before gold turns around and rockets higher. If you go short, you could be caught by an unexpected breakout beyond resistance.
That means there’s a large margin of error here, which doesn’t make for a good trade even though gold is a “sexy market” with all the media headlines about the economic collapse, the health crisis and so on.
Just look at the giant volatility recently! Recent price bars are showing literally $100 ranges each week.
Trading a market like this is like trying to catch a wave as it’s about to crash over your head. You might get a great surfing experience from that scenario, but you might get crushed right into the sand too.
I feel it’s much better to catch the wave BEFORE the energy and volatility have picked up. I want to catch the trading wave as it’s building. Not only is it less dangerous to hop aboard, I get to keep riding as the energy rises in my favor and then dismount as it sends me comfortably to the beach with a nice profit.
Now maybe that’s not an analogy that works for you, but I really want to emphasize that the best trades are the ones you identify when volatility is still low and when the trade is just getting started.
The best trades are when the price action is just starting to build some momentum from an emerging pattern.
Another key principle to keep in mind when picking the best risk/reward trades: focus on long term charts if you want to be a consistent and profitable trader over the long term. You simply can't make money by looking at a 5 minute, 15 minutes even one-hour chart because the randomness will always get you in the end.
Longer-term charts are much more predictable and give you an edge in your trading. That’s why I look at daily, weekly, and monthly charts instead.
Let me explain with a really long-term chart (45 years) for USDJPY (the US dollar against the Japanese yen):
Back in the early 1970s, USDJPY was around 350 and right now it’s about 107. That’s a sustained downtrend we can all agree on, I think.
Yet despite the length of this decline, I don't see anything happening in USDJPY to turn this pair around. In fact, I see the current consolidation as setting the stage for yet another leg down in this market.
When trends change, there should be a pattern that serves as a foundation for that directional change. But USDJPY doesn’t have one, even though I’ve had people ask me if there’s a bullish double bottom on this chart. A real double bottom should be launching higher highs, but that’s not what we’re seeing here. Instead, USDJPY is making a series of lower highs.
If a market has bottomed, the price action should be supporting that bottom with a series of higher highs and higher lows.
Instead, USDJPY looks poised for (at best) more sideways action with a strong chance of dropping significantly in the near future. To my mind, it's not a question of if but when USDJPY is headed lower. The risk of being wrong is low and the reward is potentially very high. That’s the kind of trade I like to make.
Let’s look at a weekly chart of USDJPY for more insight:
Unlike the stock market or gold, USDJPY has formed a series of classic, tradeable bear patterns which take out almost all mystery about where it’s headed next.
USDJPY has been trending steadily lower since 2015 since the formation of a double top combined with a head and shoulders pattern. That bearish double top/head & shoulders is the governing pattern for USDJPY, especially since there’s now a descending triangle of lower highs that’s also acting as a bearish signal.
Lately, another bear pattern has formed: an H top, which is a special form of a double top.
Everything on this chart points to lower future prices for USDJPY. The only question in my mind is how long we have to wait before the drop begins in earnest.
There’s the risk of having money tied up in USDJPY right now Perhaps USDJPY trades sideways for a while longer before breaking down.
But then again, there’s also a risk of not doing anything and watching this pair drop without us.
Therefore the best way to take advantage of this situation is to place a sell stop around 106.87 which is below the lows of the last few weeks. That will get us into a potentially high-reward USDJPY trade at a relatively low-risk point.
JPY is looking quite strong across the board, which means there’s another yen pair I like on the short side: GBPJPY (the British pound versus the Japanese yen):
You can see the same kind of price action price that we saw in USDJPY. There’s a bearish long-term governing pattern in the form of a head and shoulders and there's nothing in the current time frame that suggests GBPJPY is going to turn around here.
The rounding top strongly suggests we’ll see a test of the long-term lows and make all-time lows at some point.
And just like USDJPY, recent price action is also looking quite bearish. There’s a mini rounding top in the last couple of weeks where any crack below last week's low should open up a move lower.
The only real risk here in GBPJPY is that the price could continue to oscillate around current levels for a while yet before the drop comes.
Now I hate to use the word “certainty” with a potential trade, but in my mind, GBPJPY is only going to go lower. The Japanese yen is looking dominant across all its pairs right now.
Note: if you’re wondering why a strong yen means this chart (and USDJPY) will drop, JPY is what we call the cross currency in the currency pair here. The cross currency is the second position (e.g. XXXJPY) and the stronger it gets, the lower the price will drop as XXX gets weaker against a stronger competitor. (XXX is called the base currency, by the way).
I also see the GBP weakening against most major currencies.
That’s why shorting GBPJPY is so compelling. A weakening currency pitted against a strengthening currency tends to generate large, sustained moves.
GBPAUD (the British pound versus Australian dollar) offers another compelling opportunity to short GBP:
Since identifying a triple bottom here many years ago, I’ve been bullish on this pair. That’s been the correct call with several winning trades along the way.
But now I think GBPAUD’s bullish run is over. I believe we’re looking at a formidable reversal in GBPAUD thanks to the ascending broadening formation that’s just been breached.
As you can probably guess, it's called an asescending broadening formation because it starts out with a narrow price range and then expands with greater volatility.
GBPAUD has cracked through the lower end of that pattern. While it might reverse higher in the short term, the main direction is likely to be down … by a lot.
That’s because when an ascending broadening pattern is broken, the reversal generally goes to the base of the pattern, which in this case would be about the 178 level. That means you could make about $15,000 for every $1,000 you bet. Obviously this isn’t going to happen overnight, but GBPAUD does look very promising as a short over the next several months.
Let’s take a closer look at the daily chart for GBPAUD:
Each bar represents 24 hours here, whereas with a weekly chart each bar represents one week.
The ascending broadening formation is apparent here, plus a bit more. At this daily level, we can identify secondary patterns to establish the best risk/reward trade.
You can see there’s a double (or even triple) top within the ascending broadening formation. GBPAUD cracked through the neckline of this double top and also the support line for the larger pattern too.
What’s more, prices closed on the low of the most recent trading day. This is also bearish as it indicates the sellers are firmly in control.
All these combined factors strongly suggest that GBPAUD is going lower. Now we might see some rallies in the near term of course. If so, those are great opportunities to go short if you aren’t short already.
Start establishing small positions so you catch it as it moves lower.
I hope this explains what I mean when I look for trades with good risk/reward possibilities. I like to catch trades as they're coming out of the gate. It’s much easier and safer to get in as a pattern is just being established.
Also, remember to focus on long term charts. Don’t zoom in any closer than a daily chart or you’ll find your view is cluttered with too much noise. Analyze daily, weekly, and even monthly charts for the best opportunities.
And that’s it for this week!
Now you understand what I look for to hunt down the biggest opportunities.
You know why I’m staying out of the ‘sexy’ stock market and gold market for now and why I prefer low volatility markets instead.
You also know I’m bearish on GBP and bullish on JPY and which pairs are best to exploit their weakness and strength, including which pair offers the potential for 15:1 gains over the next few months.
And with that, I wish you a very healthy and prosperous trading week.
Mark "YenDominator" Shawzin