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NZD/JPY: Rare Reversal Formation Suggests Top

Last updated 1/27/2012 1:12 PM EST (GMT -5) 4 Comments

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Matthew Weller

Technical Analyst, GFT

In trading, it’s generally considered sage advice to trade in the direction of the primary trend. Oft-quoted trading mantras such as “never catch a falling knife” remind us that trying to pick tops and bottoms is often a risky strategy. However, in rare occasions when a number of potential reversal signs converge and confirm one another, there can be favorable opportunities to try to catch a reversal. The recent market movement suggests that such a moment may be emerging on the NZD/JPY.

A quick look at the daily chart reveals a clear uptrend in NZD/JPY; indeed, the pair has put in a remarkable 8 consecutive bullish closes. The recent surge has undoubtedly left rates overbought on a number of overbought/oversold oscillators, but more importantly, the price action over the past 3 days shows that the rally may be faltering.

After rallying Wednesday, rates put in a Doji candlestick yesterday, indicating indecision and a lack of momentum in the market. When confirmed by today’s bearish candle, we have the development of a rare 3-candle reversal pattern called an Evening Star*, indicating a transition from buying to selling pressure. If rates do reverse, the chart suggests there may be room down to 61.20, which marks an area of previous resistance, as well as the 38.2% retracement of the November low up to yesterday’s high.

Zooming in to the 4hr chart, a break of the near-term bullish trend line may provide the ideal signal to enter into bearish trades early next week. The trend line has been tested five previous times, indicating that a break below would be particularly significant and would likely lead to a more substantial pullback.

To take advantage, readers could set a stop sell order at 62.78 (below Wednesday’s low) with a stop at 63.85 (above yesterday’s high) and a target at 61.30 (just above the 38.2% retracement on the daily chart). This trade would be invalidated by a rally above 63.85 prior to entry.

Potential Strategy: Sell if NZD/JPY drops below 62.78, stop at 63.85, target at 61.30

  For more intraday analysis and trade ideas, follow me on twitter ( @MWellerFX ) and attend our daily Live Market Analysis webinars. Visit your local GFT website under “Seminars and Webinars” to sign up.

*An Evening Star candle formation is relatively rare candlestick formation created by a long green candle, followed a small-bodied candle at the top of the first candle, and completed by a long-bodied red candle. It represents a transition from bullish to bearish momentum and foreshadows more weakness to come.

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Comments (4)

Jackie

January 28, 2012 at 06:33 PM ET

Matt, I can't agree with you here, but I doubt that your trade idea will enter. Fundamentally, if we agree that NZD/JPY is correlated to AUD/JPY, and that AUD/JPY is correlated to the stock market, then prospects of QE3 should see all of these go much higher in the near term (see Kathy's article "Bernanke’s Openness to QE3 and Fed’s 2014 Low Rate Pledge Kills the Dollar"). Technically, you plotted a strong uptrend line on your 4HR chart, and the daily chart has a similar uptrend ... why buck this now? Based on how you normally formulate trades, I look forward to a long trade idea on either AUD/JPY or NZD/JPY in the near term. Leave the counter trend ideas for Brad ...

MWeller

January 30, 2012 at 09:13 AM ET

Hi Jackie - I outlined my reasons for taking this counter-trend trade in the article above - the clear evening star formation and break of the 4hr uptrend were signals that there was a decent probability of a potential pullback. Note that this trade is only targeting a 38.2% retracement of the rally, and not necessarily a long-term reversal, but still offers a favorable risk/reward ratio.

As with all of the trade ideas posted here, you are encouraged to closely analyze this trade before determining whether it would be appropriate for your situation and risk tolerance.

Darkdoji

January 29, 2012 at 06:13 AM ET

On the technical evidence I think this counter trend idea is sound and low risk. I do not see how the "fact" of the various correlations mentioned by Jackie matter in this case (and a move to about 61.30 will in no sense buck the trend). We see significant pullbacks all the time and Matt I think just spotted one on time. I will trade this move.

mbrad77

January 29, 2012 at 08:27 PM ET

in my opinion, you'd have to worry about fundamentals for larger moves, i.e. QE3 is announced one may just enter a dollar bearish trade almost right away. Till then all this is just talk, and empty promises from the Fed
Otherwise, i think this trade makes a lot of sense technically.

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