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This week’s question comes from Asha, who asks:
How did you know the GBPJPY was about to drop hundreds of pips? I thought the pair was in an uptrend. Thanks!
The truth is, I might be getting ahead of myself with this post.
As I’m typing the GBPJPY is still in the process of breaking multi-year channel support, so the breakdown isn’t confirmed just yet.
However, there’s no question that the pair is sliding, and fast.
This is something I’ve been discussing in the member’s area for weeks. Some had opposing views—which are always welcome—but there were a couple considerations that forced me to maintain my bearish outlook.
I’m going to walk you through both factors in this post. By the time you finish reading, you’ll have a better understanding of how to use highs and lows to spot turning points, and how to use context to your advantage.
I released commentary on Friday about this very same breakdown. You can read that post here.
Read on to learn the two methods that allowed me to take advantage of this recent selloff.
I get emails every week asking about how one can know a market is going to move higher or lower.
My response is always the same—it’s never about knowing.
You will never know what the market is going to do. That’s not your job as a Forex trader.
Your number one job as a trader is to protect your capital. Your second job is to determine likely outcomes or scenarios so that you can best position yourself to take advantage of these probabilities.
There’s no crystal ball or magic indicator that will allow you to know the future.
I want to make this clear because I think it’s easy to confuse the two. Even if you understand that there’s no way to know what will happen, it’s all too easy to see a setup or market structure as a sure thing.
That’s a dangerous way to think. It prompts you to become reckless with your capital. After all, why not risk 20% of your balance? It’s a sure thing, right?
Avoid that way of thinking at all costs. The best traders understand the importance of staying vigilant because they know that every set-up has a degree of randomness.
With that in mind, let’s discuss why this GBPJPY decline was likely.
You may recall the ascending channel I posted a few weeks ago. The pair had spent the last year carving this pattern, made up of higher highs and higher lows.
Here’s how it looked just a few weeks ago:
Clearly a bullish formation, right? The higher highs and higher lows tell us as much.
Not so fast. While it is true that the GBPJPY was trending higher, and to some degree still is, a view of the last few years paints a very different picture.
The chart above shows the last five years of price action. It’s the same channel as the one in the first chart, but now I’ve added some context to it.
Looking at this, it becomes immediately clear why the ascending channel in the first chart isn’t so bullish after all.
In fact, it has the appearance of a bear flag. Essentially, it looks to be consolidation following the 7,000 pip decline from the last few years.
If that is the case, the ascending channel in the first chart isn’t a bullish pattern at all. Yes, it’s a short-term uptrend, but it probably isn’t something you want to buy and hold for the long term, especially now that the market has broken support.
This is an excellent example of why context is so important. Sometimes all it takes is hitting the “zoom out” button a few times to determine whether a technical pattern has bullish or bearish implications.
If you ever find yourself confused about the price action in front of you, this one simple technique can clear it all up.
The best part is that you don’t need any fancy indicators. Heck, you don’t even need to draw any levels for this exercise.
All you need to do is identify the major swing highs and lows on the daily time frame.
Let’s take a look at the GBPJPY daily price action once more.
Notice how the pair had been carving higher highs and higher lows for about a year.
However, just recently the pair began to struggle to make higher highs. This should have been the first red flag if you were bullish about the GBPJPY.
Even if you just take a step back after identifying the major swing highs and lows, you can see that the market had started to change direction recently. In other words, its behavior began to deviate from the previous twelve months.
As discussed earlier, the context of this ascending channel painted a relatively bearish picture. However, the first sign that buyers were tiring came earlier this year with their apparent inability to retest channel resistance.
Trading successfully is never about knowing which way the market will move. Nobody knows the answer to that, and those that believe they do are bound to be disappointed.
There’s no such thing as bullish or bearish patterns without context. Even if a technical pattern has taken a year to play out, it’s imperative that you put it in context of the broader multi-year picture. It might just change your outlook on the market.
If you’re ever in doubt, take a step back and focus on the highs and lows. It’s a great exercise that will not only help you determine the likely path forward but also build a connection between you and the ebb and flow of a market.
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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