After long, long decline, the ever popular beast, GBP-JPY, has staged decent size rally. Question is, has it hit the bottom, or we just witnessed one of many bounces on the way there? And what can we expect from here? An all time low of 118.80 was reached about 2 weeks ago. Since that time beast ran up to just under 137.00, or about 1800 pips. This was of particular interest for me. I was in a long trade in GBP-JPY and managed to catch most of this up swing. More details on that are in a post Yen stole the show. This move surely seems impressive, but compared to the scale of preceding sell off, it barely registers. On long term charts it looks like noise, especially weekly graph. This still has a profile of a waterfall, an almost straight line down. It is very unusual profile. To illustrate the point, notice the difference, or spread between the price and 100SMA on this weekly chart. At its most extreme it reached reading of about 9000 pips, the highest in 30 years. This indicates even more severe oversold condition than huge bear moves of early 1980′s, when valuations were much higher and 9000 pips represented much smaller percentage of price than it does now.

There is technical indicator which measures this relationship. It is called a “disparity index” and it helps to spot extreme oversold/overbought conditions. It’s not plotted here because I like “clean” charts, as little clutter as possible. What typically happens in situations like these is that the price and the SMA of choice tend to gravitate towards each other. This doesn’t mean that GBP-JPY is going to rocket right back to 100SMA  but rather combination of MA moving down and price making its way up. On this chart, I think, they could meet in the area of 160-170 over next 3-5 months. On this time frame this would constitute a pull back, rather than reversal, since this down move has been of such extreme nature.
Daily chart makes a little stronger case for trend reversal. For me an important indication of reversal is for the price to get above most recent high/low. In this case it is previous high.

We can see that beast already tested recent highs on couple of occasions, market as A and B. These levels were taken out twice followed by establishment of new lows. Those breakouts failed. The more failures in the row, the higher probability that next one will be successful. On Friday price moved above136.00, breaching most recent minor high. This was the target of my trade in GBP-JPY using daily chart. Chances of the price not making NEW lows are very high. By “new low” I mean dropping under level of 118.80, but any pullback  to as low as 125 is still very much possible. I would welcome it very much for better entry. Incidentally, even though minor high C was taken out, which indicates higher prices over time, the real key for this chart is 141.50 area. Breaching this level would suggest continued move to above 160, consistent with weekly chart analysis. For me daily chart doesn’t present good trading opportunity at the moment. Entering right now gives too small target in relation to potential drawdown, with a strong resistance expectation at 141.50. But possibilities for long trades exist above 141.50 with 2000 pips objective, or on a pullback to 130 or lower, with first target of 141. So this chart is off limits to me until one of those conditions are met. As strange as it may seem, it would be better if the price failed to penetrate the 141.5o area for some time. I would like to see it go there 2-3 times and retreat. Any subsequent breakout would be much more powerful and “healthier” for the long term reversal.
Recent rally was very impressive on 4H chart, but it looks overextended. Joining in on the run now doesn’t give very good risk/reward ratio.

This chart doesn’t provide good stop for a long entry. Retracement to under 130 is possible. If I was still in a position from lower 120′s, then I could have tried to stay in. But as far as new trades here, well, not now. For that I’ll be watching even smaller time frames or wait for some pullbacks here to create additional support levels.
So, what is it? Has beast hit the bottom yet? In my opinion, most likely yes, and GBP-JPY is in early stages of recovery. I don’t expect 5000-6000 pips run this year, but if the key level of 141,50 or so is breached, than one can say with some degree of assurance that the worst is over, taking us to about 162. And, hopefully, make few pips as well.

Mike K.