Euro pairs have been on a race to the bottom ever since the German constitutional court ruled that some of the ECB asset purchases are not “legal”. Only last Friday, the EURUSD traded above 1.10, only to move below 1.08 today. The EURJPY cross followed suit, dropping like a rock from 117.70 on Friday to 114.80 today. In the midst of this rise in volatility, there are signs that it may have just completed a major shift, with chances for a potential reversal.
A falling wedge pattern on the daily chart is not for the traders that want quick action. Trading such reversals could require patience and money management. This is due to the fact that markets may continue to experience volatile swings, prior to heading to the desired direction.
After all, trading a reversal requires a contrarian view, and catching a falling knife is the one of the plays some investors may consider. However, trading it using a disciplined approach has the potential of yielding good results. Here are a few things to consider before going long based on the daily EURJPY falling wedge.
EURJPY Trading Plan
First, the price must reverse inside the wedge. The lower edge of the pattern, also called the 1-3 trendline under the Elliott Waves Theory, holds the key – typically, the last swing in the wedge’s formation pierces the trendline.
Second, the reversal must continue until the upper edge of the pattern is broken. The so-called 2-4 trendline’s break is key moving forward.
Therefore, the plan here could be to trade on the long side on a break of the upper edge of the pattern (i.e., where the grey circle lies). It already implies a move back at 117, so a reversal on the lower time frames may be underway in any case.
Third, as any trade requires a stop-loss and a take profit, if we zoom out, some may see the falling wedge forming right below dynamic resistance. It feels like the bears may keep pushing every bounce until the pair reaches a new lower low. However, if it is to carve for a bottom here and now, the stop-loss should be at the lowest point in the wedge’s formation.
As for the take profit, some may believe a move to 120 is possibly on the cards – the price meets dynamic resistance against a major bearish trendline that has held for over three years now.
Contrarian trades have the advantage of an earlier entry, while the new trend is not obvious yet. For this reason, the volume involved in such trades is typically half of the regular volume traded with a trend-following position.