"Sell" a Dull Rally Part II

Revisiting Last Week's Lesson

At the end of Part 1 of this lesson, from October 1st, we mentioned that the GBP/JPY has had a dull rally and is a candidate for a potential sell setup forming. We were waiting for some technical signs to show us a clear set up, though it didn't happen last week; mabye as a result of a holiday, Columbus Day, or for some other reason, it didnt happen.

As a "chartist" or "technical analysis" trader it is not as important to pay attention to why things are happening from a fundamental picture, we only care that they are happening, and ithat behaviour is reflecting in the price action on the chart. Therefore, one has to be watching the markets very carefully for signals that the market is providing us at any time. Today's we have what looks like a completion of a quite valid setup for a sell position. Again, the setup comes in the context of a dully rally after a strong sell-off. As we discussed in our earlier lesson, there was strong sell off, in late July to mid-August. The original market reaction after the steep drop was quite violent and the pair advanced quickly to 235. The reaction slowed down though and progressed into a labored upmove. The pair then accelerated to test the long term moving averages. At the longer term moving average, the uptrend slowed down; and again when reaching the 61.8% Fibonacci level.

Figure 1. A steep sell off was followed by a labored uptrend.

Dissecting a Sell Set Up

The current situation in the market has potential to be an interesting sell set up. The example being used here is not meant as trading advice, it is simply an excercise meant for educational purposes. With that being said, let's examine why we may have a high probability, valid, sell setup.

First we want to look at why we didn't want to sell this pair when we looked at it in Part 1 and are more interested in doing so this lesson. What makes the analysis different now that we have more market behavior to study? For purposes of this educational example, we are thinking of placing a sell stop (entry order for sell position) below the most recent low.

1. The recent action shows a labored test at the break of the long term moving average.

2. The rally slowed down again when the pair reaches the 61.8% Fibonacci retracement levels. There are multiple tests of this level, indicating a possible reversal. 3. Taking a look at the recent candles we see a relatively strong upbar, followed by a small blue candle with a long shadow on top. The next candle is, known as a "hanging man" as it shows interest in selling the pair. Tuesday's (yesterday) bar also has a quite long upper shadow. This combination of candles shows that demand is actually quite thin and supply is entering the market.

Figure 2. Three signs of a possible reversal.

Discussion of Some Strategies and Current Analysis

One technical analysis strategy is to use moving average (m.a.) crossover method. If we followed it here, when the 50 period m.a. crossed downward on the 200 period m.a., the position would be losing value right now. There is inherent lag in a simple m.a. crossover method that lessens its effectiveness in many cases.   Instead, we are entering on a swing trades, which has a sell setup after the strong market thrust which has a "suspect" trend beginning. This strategy waits for a retracement, and after the retracement, sets up an entry sell that will be triggered below 237.00.

Figure 3. Moving Average crossover is weak signal here.

The protective stop is placed above the most recent high, near 240.50 or 241 which is a risk of around 350 points on the trade. If the trade is triggered, we are looking for the market to test 229, a change of 1000 points. This sets the risk to reward at around 3:1.

After the initial reaction the strong down trend in August, the pair has testes the 229 level several times, and there is indications of some demand at this level.  If the trade is activated the first stop could be around the 235 level, which is around the highs set in late August.

Now, the strategy here places a protective stop as we will not which trades will work and which will not work out, and that is why we are attempting to have a trade with a good risk to reward ration. So, if a position is triggered below 237, then the protective stop would be placed around 240.50 - 241.

We also see that our momentum indicator has slowed down drastically, and even crossed down. This alone doesn't mean anything, as we have seen plenty of down cross of stochastic before, though they do not mean much in an active uptrend.

So, we shall see what will happen with price action this week and the next and check back and see how our experimental trade and favors.

Reproduction of Chart in Video

Here is a zoomed in version of the GBP/JPY daily chart as it is displayed in the video is presented below:

Figure 1. The analysis uses 2 Moving Averages, one a 50 period, the other a 200 period. To measure momentum the Slow Stochastic Oscillator is used, and for overbought--oversold levels, the Relative Strength Index.

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