If you were wondering what was happening with the USD/JPY, then a glance at the weekly chart for the currency pair would provide you with the answer! A classic candle pattern is now in the latter stages of development as shown by the dotted lines, and for traders who have never come across this before, it’s known as the pennant pattern. A clear sign of a market in sideways consolidation, but more than this, it also represents one which is preparing to break free.
Unlike the rising or falling triangle patterns, with the pennant pattern, we have no idea which way the market will ultimately move. As a result, one classical approach to trading this pattern is in using a ‘directionless’ position, and the simplest of these is the long straddle using options. The key to success with this approach is timing, as it is market volatility which creates a profitable position, whichever way the market moves, and provided that it does, then one of the legs of the straddle will move into profit. The problem of course is in gauging the timing. If the market fails to breakout during the life of the straddle, then the options expire worthless. A breakout on a news release or on an earnings update for a stock is relatively easy to predict, the timing of the breakout here is not, and the only judge we have at present is that the price action is tightening with every week that passes, sending a clear signal that we are approaching the end.
More profitable, and perhaps less risky is simple to wait and be patient, as breakout the market certainly will, it is just a question of when. And the ‘when’ of course, can be answered with volume.
The pennant pattern is a classic example of what I refer to as the ‘coiled spring effect’. The longer that this price action continues, then the more volatile will be the reaction when the pair does finally break, one way or the other. This is just like winding up a clockwork car. The more it is wound then the further it will travel, once released. It’s the same for the market, and in this case, the USD/JPY is now building up pressure and preparing to break free, with the current focus of the pennant flag centered on the 99.00 region on the daily chart.
For any breakout to be validated, this needs to be associated with well above average or high volume, something which has been lacking in the last few months as the pair have entered this phase of consolidation during the summer months. However, the volumes of late May and early June provide key benchmarks against which to judge volumes on any breakout, and once validated, provide the answer to the question – which direction is the market going next! And it goes without saying, that whatever the answer, the volume at price congestion zones will then define key areas of support and resistance as the market moves. The spring is now being wound ever tighter. All we need to do is be patient, and wait for volume price analysis to confirm the direction. Or, we could set up a straddle position. I think I know which I would prefer!!
By Anna Coulling