From the February 01, 2012 issue of Futures Magazine • Subscribe!

The contrarian forex trade of the year

Traders always start with two key choices in selecting trade direction. They can join the crowd, or they can take a contrarian approach. With more than $4 trillion traded each day, the price direction reflects a collective opinion with a great deal of money behind it. On the other hand, the crowd can be, and often is, caught by surprise. Economic data releases often diverge from expectations, thereby moving the market. Since the financial collapse in 2008, getting it wrong on debt exposure, global growth and the U.S. economy has become the new normal. The result of this wrong information is headline-driven panic reversals, leaving those who join too late with great losses. In contrast, the contrarian point of view is based on the premise to expect the unexpected. The contrarian mind-set is one that points to price action as prone to information shocks and not efficient. Another key concept underlying contrarian trading is that extreme price action will revert back to a mean. Of course, the trick is pinpointing when a price action technically is extreme, likely to be temporary as well as timing the trade. Detecting contrarian opportunities is a major challenge for the trader. As 2012 begins, there is one irresistible contrarian opportunity — trading the EUR/JPY.

The path to current historic lows began in September 2008 when the EUR/JPY began its downward spiral. From September 2008 until March 2011, there were no new monthly high closes. This bearish direction then proceeded to pause with only two bullish consecutive new monthly high closes, before it reversed and resumed a downward path. Although the EUR/JPY is at 10-year lows, it can go lower and probe the October 2000 valuation of 90.00. While momentum remains bearish, the possible contrarian trade of the year could be long the EUR/JPY pair. There is technical support for this approach.

We can gain further insight from a price break or point break chart history (see “Euroyen point break”). Price break charts record new consecutive highs (green) or new consecutive lows (red). If price reverses and closes above three previous lows, a new column and bullish color is shown. If a price reverses and closes below three previous highs, a new column and bearish color is shown. The value of price break charting is the ability to show unambiguously the persistence of sentiment.

The price break chart history reflects an ability for the EUR/JPY to reverse and follow that reversal with great persistence. In October 1998 the EUR/JPY reached highs of 159 and then reversed, moving to historic lows of 90 in October 2000. During this period, there were no bullish price reversals. This shows a very strong downward trend. However, when the EUR/JPY did reverse, it was followed by a long and consistent climb from 90 to 166 in October 2007. What is interesting about the bullish technical pattern that ensued is that there were no subsequent bearish price break reversals. This showed a very strong bullish persistence.

The current patterns indicate that the EUR/JPY downtrend already has showed cracks in the bearish sentiment. In contrast to previous bullish and bearish uninterrupted swings, the EUR/JPY had a price break reversal in March 2011 to September 2011, before it resumed its downward path. Also important to note is the decline in the body size of the bearish price break candles. This is a sign of weakening bearish sentiment that is prone to an impending reversal. If we add a fundamental lens to the analysis, changes in the Eurozone and Japanese economies may indicate a reversal is likely. The biggest bullish factor would be continued signs that the Eurozone crisis is being well managed. This is more likely than the yen weakening because weakening the yen has proven to be very resistant, even to intervention by the Bank of Japan.

The problem with a contrarian trade is that you could be right the trade, but not last if you are not right the timing. Options on the EUR/JPY, plain vanilla as well as bullish spreads, may buy you more time for the reversal to hit. Traders also could consider using the EUR/JPY weekly Binary options at the North American Derivatives Exchange to enter one week trades anticipating an out-of-the money momentum breakout. The reward-to-risk opportunity is appealing. For example, an out-of-the money 100.75 strike price was offered at $36 on Tuesday, Jan. 3. If the EUR/JPY settled by end of business on Friday at or above the strike, the return would be $100 per unit. Whether you trade the EUR/JPY short- or long-term, if a bullish price break reversal occurs on the EUR/JPY the potential for a 1,000 pip move is not out of the question.

Abe Cofnas is the author of “Sentiment Indicators” and the forthcoming “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of the Fear and Greed Trader at Agora Financial Inc. He can be reached at abecofnas@gmail.com.

About the Author
Abe Cofnas

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.

Comments
comments powered by Disqus
Check out Futures Magazine - Polls on LockerDome on LockerDome