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Forex Markets Are In Breakout Mode

Published 09/17/2015, 10:05 AM

Forex breakout likely, but initial move has a 50% chance of reversing.

Although the yen has been weak for the past couple of days, both the 60-minute chart of the EUR/JPY and the USD/JPY are in their 3rd pushes up, and their channels are wedges. The EUR/JPY is stronger and is trying to break above a head and shoulders bottom on the 240-minute chart. However, it is still in the middle of a 5 month trading range on the daily chart.

All Forex markets are in breakout mode on the daily charts. The Fed interest rate announcement will today at 11 a.m. PST will almost certainly result in a breakout up or down, or in both directions on the 5-minute chart. About half of the time, the breakout goes one way and then reverses and goes the other way. However, if the breakout is only 100 pips, it might not be big enough to create much of a breakout on the 60 minute and daily charts.

Inertia

The news has the potential to change the perception of the value of all Forex crosses for weeks or months, and it could lead to a breakout on the daily chart that could last for months. The problem is that markets have inertia and they tend to continue to do what they have been doing. The daily charts have been in trading ranges for many months. They clearly will breakout at some point, but despite how strong a reason for a breakout appears to be, 80% of these reasonable breakout attempts fail. That means that the breakouts that will begin today will probably fail, just like all prior attempts.

Eventually one will succeed and the trading ranges will be replaced by trends, but until there is a breakout, there is no breakout. Since this Fed announcement could change the policy of the past 5 years, it can change the perception of the value of the dollar for the next many months. This means it has a higher potential to create a breakout than most news events. Traders will not believe that the breakout will be likely to succeed until they see a strong breakout and follow-through for several days.

Look For Follow-Through

The result is that those who trade Forex markets for a living will view whatever big move that comes today with suspicion. They need to see follow-through over the next several days before they will become confident that the breakout will lead to a trend. Traders learning how to trade the markets should not get too committed to the direction of the breakout because they need to realize that even the strongest breakouts fail about 40% of the time. Traders need that follow-through. If they get it, the breakout then will have about a 60% chance of some kind of measured move in the direction of the breakout.

Since this is a possible breakout on the daily charts, the move could be several hundred pips. If there is a strong breakout, there is no reason to enter at the earliest opportunity. Entering later has a higher probability of a profitable trade. Traders who wait for that higher probability entry know that it comes with worse risk reward. The stop is further away, increasing risk, and there is less left to the move, reducing reward, but this is a reasonable trade-off.

The profit profile for those entering early or late is about the same. One gets better risk/reward, the other gets better probability, and the institutions on the other side get the opposite. This is true of all trading. If one side has better probability, the other side has better risk/reward.

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