Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine.

© 2006 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

CURRENCY TRADING

Don’t Believe The Hype

Avoiding The Herd

Mentality In Forex
Careful analysis of the technicals along with a good dose of logic and common
sense will help you become a more successful foreign exchange trader.

by Todd Gordon, CMT

here was some interesting price action in the last quarter of 2005 in

T
USD/JPY, with foreign exchange traders anticipating a break of the
important 115 level. They got it, but in a rather lackluster fashion.
As it turned out, the real level to contend with was 116. Look at the
candlestick lows, closes, and Fibonacci support levels from 2002
and 2003 that dictated price action in 2005. Armed with this knowledge, you might
have prevented a costly short trade at 115.00 and been properly positioned for
future price action.

2005 IN A NUTSHELL
October was a busy month in the forex markets. EUR/USD battled with 1.2000,
while USD/JPY struggled with 115.00. Tradable volatility that allowed for outsized
profits was not all that spectacular, but as it turned out, October’s price action set
the course for the rest of 2005. And what a finish to 2005 it turned out to be.
But first, let’s go back to the end of August, when USD/JPY first broke through
110. This new high jump-started the largest USD/JPY runup in more than six years.
Those momentous levels 110 through 114 came and went without much of a to-do,
but as USD/JPY cleared the 114.50 level and approached 115, the hype began. Bank
traders and market analysts could not talk about anything but 115.00. Their
analysis showed that 115 was the breakeven point on hedges of Japanese exporters,
who would certainly defend this level. Soon, the newspapers, magazines, and
trader chatrooms got on board and before long, every trader in the crowd was ready
to sell into 115.00.

THE HYPE HAD NO MEANING

Despite all the hype surrounding this massive resistance level, a close look at a
USD/JPY chart in Figure 1 told another story.
In Figure 1, a weekly chart of USD/JPY shows the 38.2% Fibonacci retracement
at 114.45. There appears to be a solid support level at 116.00, which repeatedly held
in 2001, 2002, and most of 2003. In late 2003, the highlighted support level of
116.00 finally gave way in a blaze of glory, leading to a 15-cent implosion, ending
in early 2005. The Fibonacci projection level of 0.618 from January 2005 lows up
to July highs compared to the September lows put the target at 116.26. On a side
note, the 1.0 Fibonacci projection level in the same series caught the high of the
entire move. So 114.50, 116.00, and 116.25 appeared to be technically significant
on the weekly chart, but what about 115.00?
During the second week of October 2005, the move to 115 seemed to be inevitable.
Armed with the knowledge that 115 was not significant on the long-term charts, the
next step was to look at an intraday chart to see if the 115.00 level made sense.

SOMETIMES THE CROWD IS RIGHT

On the 240-minute chart in Figure 2, there is a minor five-wave pattern beginning
on September 4 that, after the completion of wave IV, projected the end of wave
 Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine. © 2006 Technical Analysis Inc., (800) 832-4642, http://www.traders.com

(JPY AO-FX - Japan Yen, W) Dynamic, 0:00-24:00

1.000 (135.012) 135.00
USDJPY
- Weekly
130.00

125.00

1.000 (120.80)
120.00
0.500 (118.366)
116.00 0.618 (116.269)
0.382 (114.438) 115.00

0.000 (108.94) 110.00

105.00
0.000 (101.72)

Dec Aug Feb Aug Jan Aug Jan Jul Jan Jul Jan

eSIGNAL
2001 2002 2003 2004 2005 2006
FIGURE 1: SUPPORT LEVELS. If you go back to 2001 you will see that 116.00 acts as a solid support level. But what about the 115 level that seemed
to be an area of importance during October? You’ll need to turn to an intraday chart.

V to be up at 115.07. This nice Fibonacci symmetry of waves I and around considered another look at 115 to be their golden ticket.
IV, combined with the selling interest of the crowd at the 115 Sure enough, they sold into the 114 handle and considered
resistance level, was strong enough to reverse the USD/JPY themselves lucky as the price marched higher. And then the
uptrend back down to 114.00. This time, the masses were correct. unthinkable happened — USD/JPY sailed clear through 115,
The bottom of the retracement (from the failure at 115) is at landing at exactly 116.00, only to fail miserably. If you refer
113.75. From here, price reverses to head back up to 115.00 for back to the analysis about the 116.00 level, you can take some
another shot. Traders who were sure to see 115 fail the first time amount of comfort in the fact that you had done your work and

(JPY AO-FX - Japan Yen, 240) Dynamic, 0:00-0:00

116.00
115.38
Wave I and V Symmetry 115.07
III. 115.00
Wave I = 210 pts
Wave V = 217 pts
Wave V projected to end 115.01;
114.00
actual end was 115.07
113.00 113.00
IV.
112.00

I.
110.75 111.00

110.00

108.74 109.00
II.
08/28 09/04 09/11 09/18 09/25 10/02 10/09
FIGURE 2: THE IMPORTANCE OF WAVES. Here you see that wave V ended at 115.07. The strong selling interest at this level reversed the uptrend
and brought it to 114.00. Will it go lower or reverse?
(JPY AO-FX - Japan Yen, 120) Dynamic, 0:00-0:00

116.53

116.00 - Shows four tests before breakout B 0.000 (115.99)

116.00

115.50
141 pts
115.00 - Shows one test before breakout 0.000 (115.09)
115.00

1.000 (114.58)
0.000 (114.40) 136 pts 114.50
114.59 - 0.618
of AB
114.65 114.00
1.000 (113.73) Long entry
139 pts
A
113.50

1.000 (113.01)
113.00
10/09 10/16 10/23 10/30

FIGURE 3: BATTLE BETWEEN BULLS AND BEARS. You can clearly see the price movements between the 115.00 and 116.00 levels. There were five attempts for the
USD/JPY to push above 116.00. It finally did so, only to soar higher for the rest of the year.

were prepared for the ensuing battle at 116.00. For the calm, yet decisive trader who did not get caught up
Take a look at the price action between 115.00 and 116.00 in the noise, bids were waiting patiently at 114.65 for the
in Figure 3. There is a single test of 115.00 before a retracement emotional masses to push the market into the support level.
to 114.00, followed by the reversal higher through 115.00 up Ultimately, USD/JPY did trade up to 116 for one more failure
to 116.00. Once prices reach 115.00, the battle ensues at and retest of 115 before launching up and through 116, never
116.00. There are five attempts to achieve 116.00 on the to be seen again in 2005.
topside, and just as many tests of former resistance turned
support at 115.00. Thus, 115.00 served as minor resistance on OBSERVE, THEN ACT
the way up, but that turned out to be significant support. So Without a doubt, technical analysis is important and useful
many traders positioned themselves short ahead of 115.00 when trading currencies. However, successful forex traders
that any move back down toward this level was met with also carefully observe and take advantage of the herd mental-
traders buying back their shorts closer to breakeven, creating ity, a trap that too many traders invariably fall into. Indeed, as
the significant support level. in the examples given in this article, the technicals were faded
As if to toy with the 115-level believers one last time, USD/ while more attention was paid to the expected reaction. Forex
JPY dropped below 115 to lure the shorts who just witnessed traders who employ a shrewd combination of technical analy-
the failed battle at 116.00 for another go-round. Then, in the sis, tape reading, and simple logic will certainly reap the
last trading week of October, a tremendous long setup formed rewards.
as price broke down through 115.00. Taking a second shot
combined with stops just under 115.00 from existing longs, Todd Gordon is a currency strategist and trader at GAIN
the shorts pushed price down to a beautiful technical support Capital Group. A Level 2 Chartered Market Technician
level at 114.60 (see Figure 3). (CMT), he uses his expertise in technical analysis to produce
The two prior pullbacks contained within the trend channel GAIN’s “Strategy of the Day” research report, which identi-
equaled approximately 138 pips. If history were to repeat, the fies price trends and trading opportunities for the major
target for the third retracement is 114.62 (137 pips in length). currencies and crosses. Prior to joining GAIN in 2004, Gor-
Also found at 114.60 was the parallel trend channel support don was a director with Connors Capital, a hedge fund in Los
along with 0.618 Fibonacci retracement of the move from A Angeles. He began his professional career trading equities
to B. It was too sweet to pass up. for Aspen Trading. To contact him, visit www.forex.com.
S&C

Reprinted from Technical Analysis of STOCKS & COMMODITIES magazine. © 2006 Technical Analysis Inc., (800) 832-4642, http://www.traders.com