Japanese markets have run hard in expectation that the Bank of Japan is about to signal a far more aggressive approach to monetary policy.
Momentum oscillators though, have recently been showing classic divergence. With expectations set high, this situation looks to have potential as a buy the rumour sell the fact trade. The potential head and shoulders in the Japan 225 index is a pattern that might provide traders with a logic based strategy if a sell off develops.
Today’s Bank of Japan Decision
The BOJ is expected to make a monetary policy announcement after its meeting later today.
Shinzo Abe was elected as Japan’s Prime Minister last month. He has returned to power with a policy of applying major stimulus to the Japanese economy. The government itself has announced a 10 trillion yen spending package and has been pressuring the Bank of Japan to step up with a newly aggressive monetary policy.
It is widely expected that the BOJ will announce a medium term inflation target of 2%. This will take some achieving. The latest figures show Japan’s CPI declining 0.2%. It’s an economy with deflation rather than inflation. Deflation is a real problem for economies. It creates a disincentive to spend – why buy something now if it’s likely to get cheaper. It also advantages savers (e.g. older retired people) at the expense of borrowers (e.g. younger families in the capital accumulation phase of life). This is the opposite problem to inflation.
The expectations for today’s meeting are high. The consensus expectation is that the BOJ will announce a 10tn. yen addition to its asset purchase programme. However, many think they may go further with for example an open ended 4tn. per month programme similar to the recent Fed initiatives; a reduction of bank reserve rates and possibly a foreign bond buying programme designed to put downward pressure on the Yen.
Japan 225 CFD
The Nikkei 225 index is up 27% from mid November.
Part of the reason for this, is that international investors have long been underweight Japan. Goldman Sachs recently estimated that international investors have an exposure of only 15.6% to Japan compared to the 19.6% required for a neutral weighting. $60bn would have to be channelled into Japan and taken out of other markets to achieve a neutral weighting.
Although an ongoing reallocation to Japan could keep medium term upward pressure on the Nikkei, big trends typically come with decent corrections. The charts are indicating that if a bit of disapointing news was to come along in the near future, short term traders may get a quick downside reaction
Two features of the weekly chart suggest the potential for short term reversal:
- This week could see completion of a hanging man candle stick pattern. Last week’s candle has a long lower wick with a small real body near the top of the candle. The pattern would be completed it’s followed by a red candle this week. This would all suggest strength followed by indecision and then weakness – a series of strong green candles, a close near the same level as the open last week and finally a lower close this week.
- The slow stochastic is at extreme values close to 100%
Recent market indecision has taken the form of a potential head and shoulders pattern on the daily chart. Completion of this pattern sets up for a potential correction of the whole rally from when price bounced off the blue trend channel support back in October last year.
The classic approach here is to sell on a break below the neckline. However, this is one of those situations where traders often use the RSI to achieve early entry. The RSI is already showing divergence. A break of the RSI support (dashed line) would suggest potential for ongoing weakness and an eventual break of the neckline
Putting all this together, a typical entry strategy would be:
- Sell if the RSI closes below the dashed support line
- Forget the potential head and shoulders set up if price moves above the recent peak labelled as the “head”
If we get a setup, I’ll post a follow up discussing strategies for stop loss management and profit objectives