As we start 2011, the question arises for many traders as to which currency pairs offer the best opportunities? By stepping outside of the usual day-to-day, and even monthly scanning of the markets, we can detect patterns that are not that obvious. Consequently, we can shape some interesting strategies for the coming year. Currency pairs certainly react daily and weekly to changes in sentiment caused by new economic related information and new fears, but when looking at multiple quarters and multi-year periods, price action starts reflecting major global forces that don’t change too quickly.
From a multi-year perspective, classic resistance, support and trend lines become robust landmarks. When price breaks through them, it should get serious attention because they are at the vanguard of a possible new direction. It is useful to look at cross pairs because they leave the dollar out of the picture, and often provide more stable price geometry. When cross pair patterns break, the break is a more reliable predictor of future direction.
The EUR./AUD merits attention for this reason. A 10-year sideways range was broken in 2008, leading to a more than 35-handle move to historic highs. This was followed by a return back into the range, and then a breakdown in 2010 leading to a drop of about 77 handles from peak to trough, making an all-time low (see “What now?”). The fundamentals of economic growth in Australia and turmoil in the Eurozone certainly helped shape the pattern of the last two years, leading to the extreme lows of today. These conditions are not likely to be sustained if a slowdown in the Aussie economy, combined with some stability in Europe, occurs. The result is the potential for a significant recovery for the EUR/AUD.
The CHF/JPY crosspair offers a classic example of the value of looking at patterns. Looking back 10 years shows a remarkable sustained monthly downtrend from Q4 2003 until Q4 2008. Once the trend line was broken, a five-quarter uptrend occurred that was followed by nearly two years of indecision. At this point we have an equilateral triangle forming. When a triangle forms, it reflects a compression of sentiment where both bulls and bears are struggling to dominate, with neither side winning. The ranges between the highs and lows become narrower and narrower, leading to a breakout. Both the Swiss franc and the yen have experienced excessive appreciation. The Swiss franc has had general strength against the euro, and the yen has had strength against the dollar. This has resulted in the current stand-off with each other. It won’t last. Therefore, in 2011 there is a high probability of a CHF/JPY breakout — in either direction (see “Something has gotta give”).
Two major trading strategies can be considered. The first is anticipating a break in the current patterns. Anticipating the EUR/AUD bottoming and reversing would require a small position that you add to as price confirms a reversal. Your target is a return to the long-term range from most of the decade.
Trading a potential breakout of the CHF/JPY triangle is more difficult because the trader would have to pick a direction. This leads to the second strategy of trading on the confirmation of the break. Better to enter on a stop above or below the breakout range. As the triangle narrows, this becomes a nice lower risk trade as your stop is at the other breakout line. In the CHF/JPY the trade would occur when the monthly price closes outside of the pattern. Both trades can require multiple months to set up, so patience is a must.
Abe Cofnas is the author of “Sentiment Indicators” (Bloomberg Press). He can be reached at email@example.com.