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A Drop from the Yen Produces Trades Outside of Risk Circles

A Drop from the Yen Produces Trades Outside of Risk Circles

2010-07-27 16:06:00
John Kicklighter, Chief Currency Strategist
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It seems the EU Stress Test may have not developed much volatility on its own; but it certainly has helped distort the markets. Today, we see the risk appetite as defined by equities and commodities is slipping at a variable rate. Looking to match this underlying current, the US dollar has made a move to advance for the first time in four days. However, normal correlations start to deviate from there. Yields on government bonds from advanced economies has risen and both the Japanese yen and Swiss franc (proxies for safety) have plunged. The sharp decline from the yen and franc have offered signals on a round of trades that I have been watching. However, I given the correlation between these crosses and the lack of conviction to come from underlying investor sentiment; I am reasonably cautious. Therefore, I will look to take advantage of the positions that have developed; but reduced position size, clear stops and flexibility are imperative to ensure tentative breakouts don't turn into painful reversals.

The only position that I was still holding coming into the day was my long USDJPY. This is already on a reduced position size as it is setup for a long-term hold. What's more, the fundamental balance between the dollar and yen supplies an encouraging and positive bias to keep the fundamental bearing clear even if the speculative outlook wasn't. Adding to the portfolio today was the much anticipated USDCHF break from 1.0550. After such an aggressive decline through June, a reversal was long overdue. At the least, this can be a correction and at most a trend change. I am in half size to lower my net exposure risk to sentiment trends and my stop is set at 1.0375 with a first target equal to the initial risk. Further adding to the book are EURJPY and GBPJPY long interest (both around a third of my average size). EURJPY finally overtook 113.35; and I jumped in when a lower time frame candle confirmed it wasn't a quick false break. A stop of 150 points should be sufficient for what I expect (a reversal that stagnates back into the range would not be encouraging and I would want to get out). The long awaited breakout for GBPJPY above 136 finally brings end to a two-month congestion pattern. Entry of 136.25 offers a decent jump; but follow through is questionable as there is a larger, descending trend channel around 142. A stop of 150 points and initial target of the same will allow for at least an achievable objective.

Still slotted in my 'potential' column are EURUSD and GBPUSD. Both pairs have threatened to take over meaningful resistance (1.30 and 1.5550 respectively); but conviction is lacking. I will keep an eye on them and would prefer reversals rather than trend continuation (though that may contradict my other active positions, it would help offset the risk). I'll wait and see what happens and monitor position size and correlations very closely.

Also, I will be out the rest of the week; and will therefore be unable to update my picks. However, you can be sure I will be monitoring the market every chance I can get given my current exposure.

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