Is There A Light at the End of the Tunnel for Forex Traders?

Forex traders have been enjoying incredible volatility lately – provided that they’ve widened their stops and targets. Moves of several hundred pips in one hour are not uncommon, while similar moves used to occur over the course of a day. I’ve been trading the Japanese Yen against the British Pound (GBP/JPY) recently, taking advantage of the weakness in the U.K. economy (and by extension, the Pound) and the fact that the Japanese Yen Loves Misery. There have been plenty of opportunities to sell this pair, which has stabilized – at least temporarily – in the 170’s.

Figure 1: GBP/JPY downtrend has stabilized for the moment. Source: Saxo Bank

Using this downtrend as a guide, I’ve been selling the GBP/JPY pair short when the 14-period Relative Strength Index (RSI) indicates that the pair is overbought in the short term. RSI exists on a scale that runs from 0 to 100, with readings above 70 indicating an overbought situation, while readings below 30 point to an oversold situation. A buy signal is given when RSI crosses above 30 after passing below, and a sell signal is indicated when RSI crosses below 70 after passing above. Since the currency pair is in a downtrend, I’m only interested in the sell signals, and I ignore the buy signals. This prevents me from trading against that fierce downtrend that is so clearly indicated in the daily chart (see figure 2).

Figure 2: Two sell signals and one buy signal on GBP/JPY hourly chart. Source: Saxo Bank

How long will this continue? Well, there may be a light at the end of the tunnel. For the first time in weeks, we are getting word that banks are lowering the rates they are charging each other for 3-month USD loans. If this keeps up, expect the credit crisis to ease, and the Yen to reverse. Also, there might be a double bottom forming on the GBP/JPY daily chart (see figure 1). But for now, it’s too early to call the top on JPY, so until the Yen shows some technical weakness, I’ll continue to buy it vs. GBP and EUR.

Ed Ponsi is the President of www.FXEducator.com and www.EdPonsi.com. He has appeared on CNN, CNBC, the BBC and Fox Business News, and is a frequent guest lecturer at trading events and seminars around the world. Ed has advised hedge funds, institutional traders, and individuals of all levels of skill and experience. Ponsi is featured on the FXEducator.com DVD series, Forex Trading with Ed Ponsi, and is the author of the best-selling book Forex Patterns and Probabilities.