The dollar-yen chart shows a high degree of success in the Japanese central bankdefense of 76 yen as a support level. It’s unusual for a central bank to be able to draw a line in the sand and successfully defend it. Usually this type of defense is a signal to go short but in this case the shorts were burned.
A support level is created when the supply runs into a wall of demand. Every time selling pressure approaches a particular level it is supported by buyers who have a more positive view of the future.
This temporarily halts the price decline. In a positive sense, when all the buyers at that level have bought, the price has nowhere to go but up as buyers have to bid higher to get into a position. In a negative sense, when buyers will only bid at lower levels, sellers have to lower their ask to liquidate their position. With such a shortage of buyers, the price falls to new lows.
Technically there is an important development on the chart and this is the creation of a new resistance level. A resistance level is created when the demand runs into a solid block of supply. Every time buying pressure approaches a particular level it is overwhelmed by sellers, which temporarily halts the price advance. When all the sellers at that level have sold, the price has nowhere to go but up as buyers have to bid higher to get a position.
As prices progress, these lines change character. Once broken on the upside, the old resistance level often acts as a new support level. This is because many people have bought at this level, and they all make similar profit and loss calculations.
Resistance levels help to set profit targets in short and long term time frames.
The previous historical resistance level was near 87 yen. Traders expected the current rally to continue to this level. Instead the rally has reacted away from the short-term resistance level near 84 yen. This was created in December 2010 and tested several times in 2011 until the major retreat from 84 yen developed in April 2011.
This has two consequences. First it increases the probability of a sustained retreat from 84 yen. The initial downside target is near 80 yen. This is a mid-point consolidation area in the trading band between 76 yen support and 84 yen resistance. The dollar-yen has spent a lot of time since September 2010 oscillating around this middle point.
The second consequence is a function of the new and the old resistance levels. A successful move above 84 is quickly blocked by longer-term historical resistance near 87 yen. These two features limit the ability of the dollar-yen to continue a strong and sustainable rally. A break above 84 yen has limited upside targets.
On balance this suggests there is a greater probability of a continued retreat away from 84 yen and a retests of support near 80 yen. This will provide short-term retreat and rebound trading opportunities. In the longer term there is a higher probability of the market continuing with consolidation and sideways trading behavior between 80 yen and 84 yen.
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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