The trading community loves to use charts to analyse the markets. The candles, lines, and indicators help us to put into context big macro events and quantify the relative value to the assets we like to trade. It helps us to create some order in what is considered chaotic.
New traders don’t necessarily come from a science, or maths background, so quantitative analysis is not going to be easy for them to get a foothold into the markets. Fundamental analysis again is a longer, more laborious task, whereas technical analysis is instant. Our brain can instantly recognise a higher price than the previous day or a decline in prices over a period of time by just looking at a few candles or an entire chart.
We place meaning on patterns and one particular favorite is the Head and Shoulders pattern. Where we as traders recognise a swing high, a higher swing high which is followed by a lower swing high. This equates to the Left Shoulder, Head, and Right Shoulder.
Obviously, this shortcut is just that, a shortcut. By attributing just, the relative price, we have no idea on the fundamental reasons why price turned. We’re going with momentum and we assume that momentum will reveal future direction.
Seeing familiar objects or patterns in otherwise random or unrelated objects or patterns is called pareidolia. And what one retail trader sees, a large number of institutional traders can see too.
Traders like to front-run direction and a lot of traders will be looking at the GBPJPY and on the daily chart will have marked up the basis of a Head and Shoulder pattern. They will note that it is at the top of an extended move to the upside and a breakdown below the recent support levels would hint towards a larger move to the downside. Rather than waiting for the break lower and retest for confirmation, a lot of traders will be looking to sell high and will have places their stop losses above the right shoulder and the head. Swing highs and round numbers are common places to find liquidity in traders Stop orders.
If we look at the ActivTrader sentiment indicator it shows that 74% of the retail traders are short, which is the majority. Those traders have not taken into consideration that the Japanese government has put major economic cities and hubs under increased lockdown restrictions due to the rising cases of covid-19 infections and variations in the disease. They have also not considered that the UK is leading most developed countries in not only their vaccination rollout but also the re-opening of the UK economy as 1 in 4 adults in the UK have received at least 1 dose. The pound is fundamentally more likely to appreciate quicker than the yen, based on that alone. Where that would be wrong is if the UK suddenly had a spike in infections despite the successful vaccination program or if the world went into massive turmoil again.
Looking at the H1 GBPJPY chart, we can see that the recent swing high has been breached, and the breakout is looking likely to continue higher, as the right shoulder gives aggressive buyers ample opportunity to run the stops above. If as I suspect this continues the next target will be the swing high a.k.a The Head.
There is a distinct lack of market structure between the right shoulder and the head, with only a small area of balance around 152.80 which could act as the first line of resistance.