The pattern is created by a rally and retreat – the left shoulder – followed by a higher rally and retreat – the head – and is completed with a third rally and retreat – the right shoulder. The two low points in the shoulders are connected by a neck line. The pattern is confirmed when the price falls below the neckline and invalidated when the price rises above the peak of the right shoulder.
The right shoulder has taken many weeks to develop. The first part of this shoulder pattern was created with the rally high near 101.5 in July 2013. However, the retreat from this rally did not break below the neckline. A second, but lower rally high near 100 was made in September 2013, which created a double right shoulder pattern.
Double right shoulders have occurred more frequently since the Global Financial Crisis in 2008. These appear when the first right shoulder rally develops a retreat and then rebounds from the neckline to create a second rally that has a high that's about the same height as the first right shoulder rally. This delays the completion of the pattern but the analysis remains the same.
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The second rally was followed by a retreat and a third rally, which has paused near the 100 level. The head and shoulder pattern would be invalidated with a move above 101.5, but until this happens the price activity is still treated as a head and shoulder pattern. The head and shoulder pattern would be confirmed with a fall below the value of the neckline, the current value of which is near 0.975.
We treat this head and shoulder pattern with a little more caution in currency charts because currency trading is driven by factors others than psychology. The head and shoulder pattern is a reversal pattern; in a currency chart we use it to warn of a potential trend change rather than to set a downside target.
If we apply classic analysis of the pattern it suggests a downside target near $0.84, though this price target must be applied with caution.
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The most important upside number for the dollar yen is 102, just above the height of the first rally in the head and shoulder pattern. This is the most powerful support and resistance level on the long-term chart. It acted as a support level in 1994, 2000, and 2005 and as a resistance level in 2009. This suggests that any breakout above 102 has an immediate upside target near 107.
The pair was at 100.09 early Wednesday in Asia.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders – www.guppytraders.com. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.