Aussie has been performing very well over the past year, driven by higher than expected economic news and strong growth compared to the rest of the world. However, since November 2009, price has been ranging.  We’ll discuss and seek to predict the outcome of what’s going to happen in the following week.

Possible scenarios

AUDUSD continuation or reversal?

From the Day chart, there are 3 possible scenarios.

1. Light blue – Bullish flag pattern. Hinting a strong trend continuation
2. Orange – Triple top. Hinting a reversal pattern
3. Price continue to trade within the zone i.e. between the Red and Blue horizontal lines

Week 17 (26^th APR – 30^th APR)

AUDUSD rejected by channel; to find support

In this week, the Aussie fell at the start of the week hitting the bottom of the Green Channel before turning up again. At this point of time price had formed a lower low which meant that there could be a downward trend in place. However, there was a turn of events when price surged upwards due to growth in producers’ price on goods and consumer spending. The Aussie broke through the Green Channel and reached a high close to the previous week high and did not manage to reach or most importantly go above it and at the same time there is a strong horizontal line that was drawn on the Day chart. We can also see that price went back in to the Green Channel, signalling a false break out from the Green Channel.

Week 18 (3^rd MAY – 7^th MAY)

What can we expect in the coming week? We should be able to expect the Aussie to continue to fall until the bottom of the channel as it acts as a good indication of support. We should also be expecting a major reversal if only price closes below both the Black Trend line and the Green Channel.

However, one should be cautious to not just rely on the break of the Black Trend line as there were many false breaks before.

Moreover, fundamental factors should be taken into consideration since in the coming week there would be significant number of critical economic news releases. For instance, Australia’s cash rate would be released by the RBA on 4^th May (Tuesday) and expected forecast is an increase of 25 basis points which could push the Aussie upwards if it is fulfilled.

Multiple Time Frame Analysis is a very important technical study to master for FX trading.

The principle to follow in Multiple Time Frame Analysis is this: the chart in the higher time frame shows the larger picture or trend. It is stronger and will have influence on the lower time frame. It is therefore good practice to have a top down approach to analyze a particular chart.

As an illustration, let’s look at the weekly chart of USDX.

USDX Weekly shows a long tail doji resting on the top of a channel

From the chart above, USDX has a rally which seems to be defined by a price channel. Last week’s candlestick showed a long tailed doji star.

This two observations allow us to put together this picture:

1. USDX will continue its uptrend as long as it stays in the channel
2. Channel lows are supports, they are good retracement levels to go long
3. Channel highs are resistances, they are good profit taking levels
4. Doji star shows bulls struggling and the entry of bears

As this doji star was on a weekly chart, we can see that it can be broken down into 5 daily candles.

5 Daily Candlesticks make 1 Weekly Candlestick

To continue our multiple time frame analysis, we recall that it is good practice to have a top-down approach. So lets start by doing the weekly analysis.

Weekly Analysis 15 – 19 February 2010

Last week’s candlestick ended as a long tailed doji star. It means that the weekly charts might predict profit taking although the daily charts could show a reversal pattern. As the doji star was on the top of the price channel, this reinforces the likelihood that the USDX might take a respite from its rally.

Daily Analysis

We cascade down to inspect the daily movement of the USDX in the same week. Candles show big swings and had twice 1 day reversals (see 16-17 Feb and 18-19 Feb), which simply reflect the market’s indecision.

Putting together the two analyses, traders could do the following:

1. Because we are at the top of the weekly channel, any signal could be used for profit taking for the bull
2. Nimble traders could step in for a quick counter trend short in the lower time frame
3. Uncommitted bulls can also use any support in the day chart to buy but the optimum buy zone is the channel low in the weekly picture.

Conclusion

The higher time frame will provide a clear picture of the prevailing trend as well as show strong boundaries. These are the support and resistance and will clearly dictate movement of less committed traders using the lower time frame picture. While currency traders are unlikely to be trading the weekly charts, the concepts and principles covered here are equally applicable to other pairing time frames such as the 1-hour/4-hour or the 15-min/60-min.

When the 1-hour and the 4-hour charts are paired, the 4-hour chart gives the larger and stronger picture. When the 15-min and the 60-min charts are paired, the 60-min chart gives the larger and stronger picture as well.

Based on a Weekly Chart, USDJPY is intact on a downward Channel as shown on the chart below. Even in the last year, the USDJPY has a smaller channel and is still on the downward trend. So, it is safer to trend following USDJPY by shorting it whenever it reaches the top of the channel.

As from the same chart, the probability of bearish reversal candlesticks is high, so we should keep a watch out for evening stars, spinning tops, dojis, bearish engulfing, etc. Just last week ending 8 Jan 2010,  a hanging man variant is formed, so if this downmove is valid, the possible reversal may be at 84.88.

This is based on the assumption that USDJPY will not exceed 95.23 for the coming weeks.

USDJPY Weekly Analysis

With that long term outlook in mind, let’s consider a possible swing movement which could be taking place in the near future.
The 4-hour line chart vividly showed a possible Head and Shoulders pattern which a Right Shoulder is in midst of formation. The validity of this pattern will persist if the tip of Right Shoulder is lower than the Head.

Chart patterns provide a good way to figure out the direction of the market. A good chart pattern offers the following clues to the trader:

• Hint of market direction
• Criteria for confirmation
• Early trade signal

All in all, its qualities are predictive, pre-emptive.

Let’s look at Aussie this 2 weeks to see if clues were left for traders.

From left to right:

1. Week 49 printed a ‘Head and Shoulder’ formation (solid blue line); this is a strong hint of a bearish reversal.
2. Neckline (A) provided the confirmation of the H & S formation which acted as a pullback resistance at point (1).
3. By Friday 04 December, a more obvious H & S formation was formed with the adoption of the dotted dark blue line;  confirmation provided by neckline (B).
4. Tuesday and Wednesday of Week 50 printed a Double Bottom formation; confirmation came on Thursday with the break of the horizontal resistance (C).
5. Rather than play ‘breakout’, point (3) was a very good throwback level to go long at support.

What to look out for next week?

A horizontal channel reveals levels support at [E] that has broken on the down side. So the opening move of Week 51 could be a test of resistance at [E] and support at [F]. Price takes the path of least resistance so the integrity of both levels may provide clues for the middle of the week to come.

Aussie Dollar chart patterns

A good signal usually combines a number of qualities:

• Price follows the path of least resistance; therefore a roadmap that forms support or resistance is a good reference for a turning point.
• When the price chart prints a chart pattern, the pattern itself provides plenty of clues. Chart patterns usually fall into 3 categories:
  • Continuation
  • Reversal
  • Both of the above
• A candlestick will usually provide a trigger. Some candlesticks are better than others but they are give a hint of market sentiment at the roadmap.
• Lastly a break of a trendline is good confirmation. Note that there is only a fine line between playing ‘breakout’ versus using a trendline as trade confirmation. With the forex market, traders should always be wary of breakout trades because professional will fade the trade.

Let’s look at the EURJPY chart. This is a monthly chart which gives us an excellent illustration of the concepts involved.

Note that the chart has all of the following elements:

1. Roadmap – Channel meets horizontal resistance; level at resistance proves harder to beat
2. A head and shoulder hints at reversal
3. At the critical right shoulder, an evening star can be seen
4. All of the above come together in a confluence ultimately confirmed with trend line break

All elements of a reversal can be found here

The Aussie has retraced less than on the Euro based withdrawal from the October rally. This is the 50% fibonacci retracement level. It appears to be in a channel this week. Similar to the bear trap that we saw in the Euro two days ago, Aussie subsequently moved to a higher intra-week level although it has not been able to close above that based on the 4-hour chart.

Long term trend seen in the daily chart

Weekly chart shows the retracement, bear trap and subsequent overnight rally

Equidistant or parallel channels are extremely powerful in FX. They can even be used alone to plot price movement and trades can be taken entirely without the use of indicators.

Putting channels together, the trader can see the following:

1. Gradient or steepness of channel indicates how much energy there is in a particular movement and how sustainable it is.

2. The direction of the channel is the prefered direction of trade.

3. Boundaries of the channels act as resistance or support; they are also the most attractive point to buy or sell.

4. The width of the channel indicates potential profit attainable; trades can be evaluated entirely based on reward-risk ratio.

5. When multiple channels meet, chart patterns form as forces fight. These areas of congestion tells a trader when additional volatility might be expected. (See example in the illustration where two ‘colliding’ channels lead to price movement with a wedge.)

6. When steep channels run out and gentle channels take over, a movement is more sustainable but can also suggest reversal in the near future.

Now how can a trader make use of channels to win money? Here are some rules to help:

A. Instead of drawing single trendlines, draw only channels in future to visualize boundaries.

B. Only trade in the direction of trend.

C. Trade only when the reward – risk proposition is high.

D. Do not play break out.

Simple trading method using parallel channels

Voila!

Price pull back to a resistance trendline has tested the latter thrice.  The resistance continues to hold and could spell implications on the strength and direction of the sterling in the near future.

Risk-Reward zones are immediately visible and offer clear guides to swing traders and scalpers