USD/JPY rising wedge formation points to a reversal. Contrarian traders should wait for the price to close below 114 on a daily basis before taking action.
The trade of the year so far was a long position in the USD/JPY pair. Right at the start of the year, the currency pair dropped below 103 and then never looked back in the eleven months that followed.
While the bullish trend is undeniable and brought profits to those willing to bet on the JPY depreciation or the USD’s strength, it is time to be cautious regarding further upside.
This is not to say that further strength is impossible. A rising wedge pattern like the one seen below is a double-edged sword because it can act as both a reversal and a continuation pattern. To bears’s advantage, more often it acts as a reversal pattern, but even in this case, patience is needed.
Can the market still move higher? Sure it can, but bears do wait for a break for the so-called 2-4 trendline.
What is the 2-4 trendline and what does it matter when trading wedges?
A rising or falling wedge typically has a five-wave structure. That means that the market advances or declines forming a pattern having five segments.
The easiest way to interpret a wedge is to label it with numbers. Because of the five segments, one would need numbers from 1-5.
The trick here is to label the higher highs and the higher lows. Next, to connect them using a trendline easy to find on all trading platforms.
It is at this point that the wedge is visible. However, before acting, a few things should be remembered.
First, the two trendlines – the 1-3 and the 2-4 trendlines. In any wedge that acts as a reversal pattern, two things must happen. One is that the price should pierce the 1-3 trendline. The other is that the price should next break the 2-4 trendline. In the case of this rising wedge, the first condition is met, while the second one is yet to come.
Second, any trader should be aware that a wedge is not always acting as a reversal pattern. The thing to do is to monitor the break of the 2-4 trendline and then target 50% retracement of the entire pattern. The target is reachable unless the price makes a new higher high (in a rising wedge) or a lower low (in a falling wedge).
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