I am honored to feature this guest article by active currency trader and friend, Derek Ching. Derek maintains a Series 3 & 30 license as a registered CTA (commodity trade advisor) with the National Futures Association. As managing director for Hawaii Forex, he provides technical training and strategies for professional traders on DiNapoli Levels, a sophisticated form of advanced Fibonacci analysis. More information can be found at http://www.hawaiiforex.com/. Republication Rights Granted.
Since April the value of the US dollar (USD) has steadily lost value against the Yen (JPY). Across the Asia Pacific, the USD/JPY cross rate remains a key gauge or barometer of a two-way play of global economic fundamentals and risk aversion.
The barometer has experienced many high and low points in the last 26 months. In June 2007 the USD/JPY traded a five-year high of 124.16 to the USD. As far as the fundamentals were concerned, that five-year high was more about a weaker Yen, rather than a stronger US Dollar. Over these 26 months, through better and worse, USD/JPY has declined as the Yen has appreciated 25 percent against the US Dollar.
Chart 1. DiNapoli MACD Predictor
This 25 percent decline in USD/JPY is illustrated in Chart 1, with the initial change of trend signal appearing soon after the USD/JPY five-year high in June 2007. The red line over the price bars illustrate the MACD predictor (referred to as DiNapoliMP or “DiNapoli MACD predictor”). The regular DiNapoli MACD is shown at the bottom the chart.
The mechanics of the predictor are relatively simple. As shown in the chart when the price of USD/JPY fell below the red line on the price axis (MACD predictor), the corresponding trend as shown on the regular DiNapoli MACD is bearish (the MACD line is below the blue MACD signal line). The advantage of the MACD predictor is it gives a specific point reading on the price axis when the trend on the regular MACD is turning up or down ahead of market action. That price point for mid 2007 was a close below 118.60 for a confirmed bearish trend.
Fast forward and the USD/JPY is now trading circa 92.00. There have been some key turning points over the past 26 months, no more so than the vacuum on global risk appetite produced by the events of the third quarter of 2008.
As the risk of systemic failures grew in the third quarter of 2008, investors shed risk in earnest and moved to liquidate a five year trend of carry trades. The carry trade is the well-known strategy that involves global investors borrowing Yen and investing it in another domicile, typically directed to stocks, commodities or emerging markets. The estimated size of the carry trades was in the vicinity of ¥1.2 trillion in 2008.
For five years carry trades had been facilitated with an abundance of Yen liquidity and low interest rates in Japan. The subsequent buying back of Yen saw USD/JPY fall 21% from August 2008 lows to a low of 87.11 in December 2008 (Chart 2). Momentum into the 87.11 low during December 2008 provided the next DiNapoli signal.
Chart 2 illustrates the DiNapoli Oscillator Predictor (OP) that provides overbought and oversold levels. Note the low formed during October 2008 near the OP oversold level (Price low = 90.88 Oversold level = 91.18). The price low illustrated in Dec 2008 was well oversold with the low at 87.11 and lower OS band value at 88.59. This presents a long term DiNapoli bullish opportunity, which can better defined by narrowing the lens to a daily chart.
Chart 2. DiNapoli Oscillator Predictor
Chart 3. DiNapoli Trend Trade on Fading Stochastics
Chart 3 presents the bullish opportunity in December 2008 presented in Chart 2 with a daily timeframe with an MACD predictor line and a stochastic indicator at the bottom of the chart. The refined buy signal according to DiNapoli technique is not given at the crossover of price and the MACD predictor line, rather seven sessions later on 30 December 2008.
The refined entry (in purple) occurs on the fading of the DiNapoli preferred stochastic, that is the %K red line moves from above to below the %D blue line. Note the stochastic actually turned down in the midst of a strong bullish trend. The buy signal is generated on the probability the weaker Stochastic will correct itself in line with a strong trend in the DiNapoli MACD setting.
Chart 4 presents the same time period as Chart 3 for the USD/JPY and incorporates the DiNapoli Oscillator Predictor band to produce a Logical Profit Objective (LPO). The target price for the long generated on 30 December 2008 is represented by the upper predictor band (in blue) at 93.14 on 5 January 2009.
Chart 4. DiNapoli Logical Profit Objective (LPO)
Chart 5 presents another DiNapoli trade signal that soon followed the conclusion of the long view on 5 January 2009.
Adopting a weekly perspective, a longer position play was signaled in February 2009. Chart 5 illustrates a longer term weekly pattern signal using the DiNapoli displaced moving average (DMA), illustrated by a blue line. Parameters are referenced from the book Trading with DiNapoli Levels.
Because of the specific format of the crossovers into the week of 6 February 2009, a reversal “Double Repo” pattern appeared, completed as the initial signal bar closed above the DMA at the end of the week. The next step for a DiNapoli trader would be to again alternate the timeframe to a daily chart, to evaluate a trade entry.
Chart 5. DiNapoli DMA & the Double Repo
In breaking down the weekly entry signal of Chart 5, the DiNapoli oscillator predictor is applied in Chart 6 on a daily timeframe. The proximity of the price of USD/JPY to the overbought band illustrates that an attempt to enter at the high of the weekly signal would be a mistake given resistance and the overbought level near 92.16. To further fine tune the entry price, a DiNapoli Retracement tool is applied to produce a “K” confluence zone (purple range) for entry consideration.
Chart 6. DiNapoli Retracement and the “K” Confluence Zone
Chart 7 presents a weekly chart, the relevant timeframe to assess a longer term view of logical profit objectives based on DiNapoli levels. These levels incorporate Fibonacci Levels, rather than DiNapoli Oscillator Predictor band. As initially illustrated in Chart 1, the higher price objective near 101.66 represents a “K” confluence level of resistance. This resistance level provided a trade target in April 2009.
Chart 7. Logical Profit Objective (LPO) using DiNapoli Levels
Since the 101.66 resistance served in April 2009, the USD/JPY has declined. In fact, the subsequent months saw dynamic pressure from resistance at that “K” level of confluence in the USD/JPY illustrated in Chart 1. DiNapoli levels had forecasted strong resistance at “K” on the monthly chart several months earlier producing a confluence level from the low of 12/2008 well in advance. Following the election of the Democratic Party of Japan (DPJ), the USD/JPY traded down to its July 2009 low near 92.00.
Despite the USD encountering post election support against the Yen near 92.00, the fundamental future for the Yen certainly looks stronger. It is certainly the subject of debate if five years of carry trades were liquidated within the space five months. However, caveat emptor, the carry trade could return to the radar with the expectation that the US Federal Reserve starts raising interest rates in March 2010, sustainable time for industrial production and employment to bounce.
Moreover the catalysts for the two major waves of weakness of the Yen over the past 18 months cannot be entirely put to rest be it, energy price risk, risk aversion and carry trade, cyclical downturn, trade and corporate outlooks. The first wave spanned 6 months from March to August 2008 and the second wave spanned January to April 2009. Both these declines saw Yen shed 15 percent to the US dollar.
Further, Japan’s state of economic health going into 2008 and the inability to rebalance or restructure its economy like South Korea and China has seen underperformance in the recovery of the Nikkei 225. The decline in the Yen was only salvaged by a return of global risk appetite in March 2009.
The future trajectory of the USD/JPY will be influenced by the world at large and the rebalancing acts that can be managed by the DPJ. While the current trend suggests further Yen strength, the Bank of Japan is also to be tested with global central banks breaking from their unilateral policy framework to accommodate divergent economic outlooks.
An Intraday Example
An intraday example could be seen during the recent non-farm payroll report at 12:30a GMT on 09/04/09. The USD/JPY had hit a high at the 61.8 retracement node near "K" confluence just after US unemployment data showed some optimism with non-farm payrolls (NFP) falling in August by 216,000 being less than the forecast of 230,000 illustrating a slowing down of job losses in the US. As derived from the "F" focal point low on 9/3/09 4:00 GMT bar, "K" was created in advance via reactions 1 & 2 as shown by the 4 hr chart where resistance is at as of this posting.
From a trading perspective, the application of technical analysis using DiNapoli Levels allows one to adequately manage risk across markets, especially in Forex. The beauty of this approach is that there is little guesswork by relating a practical application of Fibonacci techniques to forecast opportunities in advance entering on a retracement and exiting at predetermined profit objectives.
Those interested in trading currencies may consider E-Micro FX products at the CME (Chicago Mercantile Exchange), allowing complete market transparency with over $100 billion in daily liquidity. Over-the-counter or “spot” dealers should be scrutinized carefully as off-exchange retail foreign currency products/services are not conducted on an exchange unlike futures accounts.
Further education and training of DiNapoli levels can be found at Hawaii Forex (http://www.hawaiiforex.com/).