FX markets lend themselves well to Elliott Wave analysis, which is based on crowd behavior. The USD/JPY, in particular, exhibits a clear long-term Elliott wave pattern.
A perfect five-wave decline appears to be unfolding from the 1971 high in the USD/JPY. Wave 3 of the decline was extended and divides perfectly into five waves itself. Wave 2 was a sharp zigzag correction and Wave 4 a triangle (A-B-C-D-e), which satisfies the guideline of alternation (if Wave 2 is sharp, then Wave 4 should be shallow and vice versa). Relationships within the triangle, which took 12 years to unfold, underscore the validity of the overall pattern. Triangles unfold in five waves (A-B-C-D-E), as is evident in “Long-term set up.” Wave E is close to 61.8% of Wave C. Alternating legs of triangles are often related by 61.8% or a derivation of ? (Phi….618). Wave E would be exactly 61.8% of Wave C at 122.57. The top was at 124.13. A difference of 155 pips when projecting a move that is nearly 3,000 pips works out to a very small error. Each leg of the triangle took (from A to E) 41, 16, 27, 37 and 30 weeks. The average length of time for each leg is 30.2 weeks. Wave E took 30 weeks. Simply put, the 'look' was right.
But the triangle already occurred. What is the implication? The implication is for the USD/JPY to dip below the 1995 low of 81.12 in a fifth in order to complete a five wave decline from the 1971 high. The various guidelines, such as alternation between Waves 2 and 4 and the internal relationships within the triangle, inspire confidence in this unfolding pattern.
Let’s look even further out. Triangles are terminal patterns, meaning that the break from the triangle completes a larger pattern. In this case, the break is lower and is probably a fifth wave that will complete a five wave decline that began more than 30 years ago. So, a drop below 81.12 will satisfy minimum expectations for the decline from 124.13 and give way to a multi-year low. As the decline from 124.13 progresses, we will be able to better determine at what point the decline will end.
Detractors will argue that the Bank of Japan would never let the USD/JPY go that low. Similar arguments have been made regarding the Bank of Canada and USD/CAD parity and the European Central Bank and EUR/USD 1.50. Remember, markets have a life of their own and that life is collective psychology, which manifests itself in the waves on the charts. In the case of the USD/JPY, a fifth wave decline may end below 81.12 in 2008.
Jamie Saettele is a technical currency strategist for Forex Capital Markets LLC