May 16 – May 20, 2011 Weekly Winner: EUR/JPY Setup Grabs 140 Pips

Before you check out the sweet setup that formed on EUR/JPY last week, y’all should check out my introductory post on the Weekly Winner to educate yourself with my trading framework.

May 16 – May 20, 2011: EUR/JPY Price Action Review

EUR/JPY Hourly Chart

While the yen did react to merger and acquisition deals and concerns from the BOJ about the strength of the yen, EUR/JPY’s price action was mainly driven by sentiment towards the euro.

Aside from a much needed correction after the euro’s steep drop the past two weeks, euro pairs got a nice boost from strong CPI figures, which showed that inflation (2.8%) was still hovering way above the ECB‘s target of 2.0%. After bottoming out around 113.50, EUR/JPY climbed steadily up the charts over first four days of the week.

However, once the clock ticked Friday, it was like a classic drive-by shooting! After chillin’ out at the 117.00 handle, EUR/JPY dropped when news broke out that Fitch downgraded Greek debt. By the end of the week, EUR/JPY was covered in red (candlesticks that is) and had lost nearly 140 pips from its highs!

So how could I have made a play on this pair?

Early in the week, I did try shorting at 115.50, but that didn’t turn out too well. However, it seems like I was just too eager in trying to pick a top. As it turns out, 117.00 served as a good resistance point, as EUR/JPY could not convincingly break above it.

I think the best way to play this particular setup would have been to go short at the resistance point with a tight stop.

First, a tight stop would have been appropriate since we were merely trying to pick a top. By utilizing a tight stop, we could have maximized our potential reward-to-risk ratio.

Secondly, with sovereign debt concerns still on the minds of many traders, it’s no surprise that traders took some quick profits and got out of their long positions once news of a Greek credit downgrade hit the airwaves.

If we had gone with a short at 117.00 with a 40 pip stop and held on till the end of Friday, we could have gotten a solid 3.5:1 reward-to-risk trade. Not bad for a day’s work eh?

Looking ahead, I think we could see similar setups in the future. Greece is definitely not out of the woods yet, and with the IMF still without a successor to Dominique Strauss-Kahn, who knows when the IMF and euro zone leaders come up with a solution!

That’s all I’ve got for now, but be on the lookout on Wednesday, I’ve got a lil’ something-something cookin’ in the kitchen for y’all! No, it ain’t glazed bunnies, but I still think you’ll enjoy it!