CAD: JPY looks like a chart with potential for a major correction.
Faced with an uptrend that’s been the proverbial freight (or perhaps bullet) train it would seem prudent not to take it on just yet. That said, the obvious supports are a long way below the market at this stage. If a reversal is in prospect, it would be nice to get short well before we break through those levels.
In this situation, using indicators like MACD can be a good compromise. They can indicate an improved chance that the major uptrend is in fact breaking down but allow a significantly earlier entry than waiting for a move under long term supports.
Signs of Weakness
A couple of things suggest that this might be a chart setting up for a significant decline
- First the fact that the last move down took out or overlapped through the major peak at 91.49 (thin dashed support line). This suggests potential for a corretion of the major uptrend and not just the last swing higher
- Second, the peaks in the MACD have getting lower and diverging with the higher price peaks. This indicates weakening upward momentum
The obvious possibility as things currently stand is a large double top formation.
The trouble is that assuming that there will be a double top and selling now still looks pretty risky. Firstly we have not actually made a trend peak. Yes, we’ve stayed below last Friday’s high but we haven’t started making lower lows. To do that we’d need to move below last Friday’s large candle. Even then, the success rate on double tops prior to a break below the support between them is only 35% (see Thomas Bulkowski’s Encyclopaedia of Chart Patterns).
Amongst the possibilities here is that we continue to drift higher but end up making some other sort of reversal pattern. If this sort of thing happens it will be possible to draw an up trend line under supports that could be used for a much earlier entry than the current support between the 2 possible double tops (2nd dashed support line)
In the meantime, the MACD trend indicator could be used to provide an early entry trigger in case we don’t get any help from trend lines. The MACD histogram (bars) can be used for this.
One strategy for MACD is to look for good price divergence to identify potentially interesting reversal trades and then sell if the histogram falls below the zero line (see arrow). Because MACD is calculated using closing values, a prudent strategy is to enter on the opening of the first candle after a histogram bar closes below zero. For traders using daily charts this means simply checking the chart a bit before 8am each morning.
This strategy would be negated if any rally from here becomes too strong. The clue here is that the peaks in the MACD itself stop diverging with price. If the MACD makes a peak above the divergence trend line the set up would be negated