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Rob Nicholas <rob-nicholas@cox.net> asked me to comment on a proposed trade. Now I don’t have an advisor’s license so I am not commenting on his proposed trade but as an example of how I would approach the issue.

Figure 1 and Figure 2 are the monthly and daily charts of the USDJPY.

rob-usdjpy-monthly.png

FIGURE 1 Monthly USDJPY

rob-usdjpy-daily.png

FIGURE 2 Daily USDJPY

The idea is the 12-m (yearly trend) is in a sideways market and since the market is in the long-term support zone, we’d buy on a close above a close above ‘A’ and exit around 113-114.

On the face of it, this looks like a nice trade setup justifying a normal size position. But if step back to look at more data, we’ll see the data disclose some negatives. Figure 3 is a representation of the 12-m but rather than squash the data, I have used yearly bars

02-15-2008-y-usjy.jpg

FIGURE 3 Yearly USDJPY

Figure 3 shows that after the low at 79.70, the market has been forming a sideways pattern with declining highs and almost horizontal lows. The 1-period swing highs are marked on the chart. The lows are 101.26 to 101.67. Viewed in this light, we immediately see the market may be forming a long-term descending triangle.

But, having said that, I need to tell you that I don’t personally rely too much on triangle patterns. This point is if I see one, I make a note of it and consider it in my context analysis.

Figure 4 shows the pattern I am relying on: the formation of the familiar Market Profile bell curve.

02-15-2008-12m-2-usjy.jpg

FIGURE 4 12-m USDJPY Market Profile

Figure 4 shows that the risk to this market is to the downside. Why is that? At A and B the market formed rejection extremes. Since coming off ‘B’, the market has formed around the middle of the AB range, a sideways congestion. This is the Value Area or the 1st Standard Deviation. I have drawn a red P to show the current formation.

On completion of the Value Area, the market breaks the bottom of value (101.26) and moves towards the AB Primary Buy Zone. It completes the sideways market by turning up to form swing low C. I have drawn a red ‘B’ to show the completed formation.

There are two lower probability events:

  1. The market will accept above the top of value (about 124.20). If this happens, we can expect a breach of 147.62.
  2. The market will continue the downtrend on reaching 79.7 and, rather than bounce and form C 79.7, will give way.

But the most likely occurrence is a move below the value area and a bounce off the Primary Buy Zone to complete the sideways market pattern.

Of course the 12-m is a timeframe providing context only. There is nothing preventing the market from moving above 108 to 113-114 and then falling below 101.26. But this sideways market is long in the tooth and I consider the breach of 101.26 a real and present risk.

For this reason, I would halve my normal position size if I am in a normal ebb/flow state. If I am trading below optimum, I’d cut the size down to a quarter or perhaps by-pass the trade.

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