The Dow Jones Industrial Average has stumbled at a major level so far this week. I mentioned this trend line inside the member’s area last Thursday, noting that it (17,650) would be a big test for the market.
Sure enough, yesterday’s session closed down 80 points following Tuesday’s retest of the level.
The first chart below is the one I posted last Thursday while the second shows the Dow during yesterday’s session.
For those who are unfamiliar with the correlation between equities and currencies, you may be wondering what this has to do with the Forex market. After all, we trade currency pairs, not equities.
To be as succinct as possible, it’s a measure of fear, commonly referred to as risk-aversion or risk-off. To tie that in with the Forex market, one currency in particular has tracked this type of risk sentiment extremely well over the years. That currency is the Japanese yen.
For all the market junkies out there, the IMF released an eighteen-page white paper that explains all the nuances in grave detail.
But for those who don’t have trouble sleeping and therefore don’t need to read the white paper, all you really need to know is that when the equity markets begin to fall as a whole, the yen tends to appreciate and vice versa.
So when the Dow retreats from a ten-month resistance level and pairs such as the GBPJPY and AUDJPY begin flashing bearish signs, I pay attention.
In the case of GBPJPY, there is no denying that the pair has struggled of late. For instance, when I made my bearish call late last year for a 1,700 pip drop, I never would have guessed it would hit its target in six short weeks.
As if that weren’t enough to put things in perspective, we’re now 2,500 pips lower than we were in mid December. But as of this writing, I don’t see any signs to make me think this trend is stopping any time soon.
With this in mind, yesterday’s inside bar could trigger a move that would retest the current 2016 lows near 156.00. Do note that this is also the 50% Fibonacci retracement level from the 2011 low to the 2015 high.
While the more aggressive traders may want to consider this inside bar a valid trade setup, others may prefer to wait for a break below the 156 area before looking for a short entry.
Besides offering a more favorable risk to reward ratio, waiting for a break below 156 could open up 900 pips worth of potential as the next key support level doesn’t come in until the 147 handle.
A yen cross I mentioned recently is AUDJPY. At the time, the wedge that had formed on the 4-hour chart looked primed to give traders guidance on the future direction of the risk-sensitive pair.
Although the pair broke higher initially, the bulls failed to hold the line and quickly surrendered those gains during yesterday’s session. Lucky for us, there was no signal to go long after the bullish break so no harm done.
The failure to hold wedge resistance as new support may have presented an opportunity in and of itself. As I often say, a false break in one direction typically leads to a continuation in the opposite direction.
We’ll soon know whether AUDJPY decides to be the norm or the exception. If it does continue lower, the first level of support that would challenge sellers comes in at 83.35 followed by the 82.00 handle.