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Standby for a dollar-yen rebound rally

Monday, 24 Feb 2014 | 6:17 PM ET

As investors continue to question the long-term effectiveness of Abenomics before a sales-tax hike takes effect in April, where the yen's headed is anyone's guess. However, if chart patterns are anything to go by a further weakening of the safe-haven currency is in store.

The yen fell to its lowest level against the U.S. dollar in three weeks early last Tuesday after the Bank of Japan extended three special loan facilities by one year and boosted the maximum amount of the loans – a move the market interpreted as a "mini ease." However, the Japanese currency remains off of recent multi-year lows above 105 per dollar touched in late December.

(Read more: The most important indicator in the world: The yen)

While uncertainty over how investors may react to the April sales-tax hike could keep the yen from weakening further in the short term, charts indicate a test of 110 may be in the cards.

Chart patterns are predictable, which makes them a gem of a tool for trading. The dollar-yen weekly chart shows an upward sloping triangle. If the pattern develops and completes as expected it gives an upside target of 110. It's not the sort of move that you want to be on the wrong side of.

But step back for a moment. Predictable doesn't mean the USD/JPY will go to 110. Predictable means that when this type of pattern appears on a chart there is a high probability that the pattern will develop with an upside breakout. Here, there is a high probability – around 80 percent – that the breakout will achieve its projected upside target.

(Read more: Emerging market rout could maim weak yen policy)

Thus, there is a low probability – around 20 percent – that the pattern will fail to develop as expected and the price will fall below the lower edge of the chart pattern. This 20 percent failure rate also includes those trades where the price breakout does not rise enough to achieve the chart pattern price projection target.

Predictability means we can establish the probabilities of particular outcomes with a high level of confidence. The chart pattern sets the potential target, and it also sets the exact price level at which we know the pattern has failed. That's the stop loss essential for all trading.

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The triangle chart pattern has three elements.

The first is the support/resistance level. This is near 101 on the weekly dollar-yen chart.

The second is the upward sloping trend line that defines the lower edge of the chart pattern. This starts from the low of 92.6 in April 2013, and uses the lows in June 2013 and the two lows in October 2013 to set the position of the uptrend line. A fall below this line would signal the end of the pattern and the end of the uptrend that started in February 2012.

(Read more: How bad will the Nikkei meltdown get?)

The third, and an essential element that completes the pattern, is the base line. This is created by 1 to 5 candles of price activity moving in the same direction. The dollar-yen chart uses six candles, five of which are green. This is the base of the triangle. Its height is measured, and this value is projected above the support/resistance level to give a projected upside pattern target near 110.

There is a high probability the 110 target will be achieved. Note, the dollar-yen may fall as low as 100 – the value of the uptrend line – and still remain consistent with the development of this chart pattern.

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.

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