Currency Secrets

Not all flag formations work out the way as planned. This really isn’t saying anything profound.

However, just as each flag formation has a break point where we know it is likely to continue in the direction of the flag pole it EQUALLY has an opposing break point where when its opposing break point is broken we will see the market retrace back to the start of the pole.

But trading the inverse break does take some knack.

First, we need to know where this break point exists. As a general rule most flag break points occur around the 50% mark of the flag pole, however, experienced traders can sometimes pinpoint earlier entry points and one of these earlier entry points is where the second peak/trough occurs during the consolidation/flag period.

In the case of the GBPJPY and CHFJPY formations yesterday I identified the second peak in both charts. I knew that if these prices were broken it would end the flag formation for how it should normally be traded (being in the direction of the pole).

But what would’ve happened if we’d traded the inverse break?

Entry for the inverse break would’ve been at a move above the 218.31 (+ spread) point, with stops being difficult to place but are generally placed at the low of the flag pole (now can you see why it’s important to have the flag stay within the pole’s range, if we have wicks passing through the extreme it’s hard to not only find entry, but also where to place stops on the inverse). Our target would’ve been the other extreme of the pole being 220.34 which hasn’t been reached on the GBPJPY yet.

GBPJPY chart

On the other chart – the CHFJPY – we would have had entry at the break point of 93.75 (+ spread), with stops either at the low of the flag pole or at the low of the wick that pierced the flag pole’s low. Interestingly the CHFJPY hit its target, being the high of the flag pole at 94.68 (just under 90 pips made).

CHFJPY chart

What tell tale signs were there that the CHFJPY was MORE probable to achieve its target than the GBPJPY?

Not surprisingly the CHFJPY is also forming a bearish flag, however, I’ve never traded the CHFJPY and aren’t likely too regardless of how nice the flag looks.

(The EURJPY is forming a bearish flag too but it isn’t as nice – it has already had closing hourly bars beyond the low of the flag pole at 147.83 making entry a little difficult, although having said that this would imply the EUR is weaker against the JPY than the GBP and the CHF.)

So I’ll be a spectator on this one, and will watch to see if the flag formation unfolds.

Several things I like about the CHFJPY in comparison to the GBPJPY discussed previously is that the CHFJPY has only had one snap at the low 93.29.

Okay, what’s the first thing I check after seeing a potential flag? Announcements. And there’s nothing on the announcement front for the CHF or the JPY so if there were to be a break this may take a little longer but also may be more directional (no whipsaws from volatile announcements).

Alright, what’s our risk:reward?

The flag pole distance is… 94.68 – 93.29 = 139 pips

If we place our sell entry stop at the low of the bar that saw it move below 93.29 (being 93.22) where would I place my stops?

Just as with the GBPJPY analysis I’d be inclined to place it above the high (+ spread) of the second peak formation in the flag consolidation period, being 93.75 (+ spread). My risk for this trade would then be…

93.75 – 93.29 = 53 pips

Our risk ratio is 53:139 equating to 1:2.6, and again to improve this ratio I’d probably look to sell a small amount of lots NOW with stops above 93.75 (+ spread) knowing that if the CHFJPY were to get to this level the entire bearish flag formation would be nullified.

But again, I’m not likely to trade this currency pair as I’ve never traded flag formations on it before.

(Interestingly though the high on 31 August @ 95.65 and the low of 5 September @ 93.65 gave us a 50% zone @ 94.65 – the highest the currency got on 7th September last week was 94.68 before it eventually fell its 139 pips forming this week’s flag pole.)