Price action behaviour of USD/JPY

In my previous post, we note that USD/JPY seems to haze an on/off switch when compared to the other major currency pairs. Add to that the fact that USD/JPY liquidity can be similarly fickle. Sometimes, hundreds of millions of USD/JPY can be bought or sold without moving the market noticeably; other times, liquidity can be extremely scarce.

This phenomenon is particularly acute in USD/JPY owing to the large presence of Japanese asset managers. As mention in my post before this,  the Japanese investment community tends to move en masse into and out of positions. Of course, they're not the only ones involved in USD/JPY, but they do tend to play the fox while the rest of the market is busy playing the hounds.

Prone to short-term trends, followed by sideways consolidations

The result of this concentration of Japanese corporate interest is a strong tendency for USD/JPY to display short-term trends (several hours to several days) in price movements, as investors pile in on the prevailing directional move. This tendency is amplified by the use of standing market orders from Japanese asset managers.

For example, if a Japanese pension fund manager is looking to establish a long position in USD/JPY, he’s likely to leave orders at several fixed levels below the current market to try to buy dollars on dips. If the current market is at 116.00, he may buy a piece of the total position there, but then leave orders to buy the remaining amounts at staggered levels below, such as 115.75, 115.50, 115.25, and 115.00. If other investors are of the same view, then they‘ll be bidding below the market as well.

If the market begins to move higher, the asset managers may become nervous that they won’t be able to buy on weakness and raise their orders to higher levels, or buy at the market. Either way, buying interest is moving up with the price action, creating a potentially accelerating price movement. Any countertrend move is met by solid buying interest and quickly reversed.

Such price shifts tend to reach their conclusion when everyone is onboard - most of the buyers who wanted to buy are now long. At this point, no more fresh buying is coming into the market, and the directional move begins to stall and move sideways. The early buyers may be capping the market with profit-taking orders to sell above, while laggard buyers are still buying on dips. This leads to the development of a consolidation range, which can be as wide as ¥l or ¥2, or as narrow as 40 to 50 pips.

Short-term traders can usually find trading opportunities in such consolidation ranges, but medium and longer-term traders may want to step back and wait for a fresh directional movement.

Technical levels are critical in USD/JPY

So if you‘re a regular trader or investor and you don’t work at a Japanese bank, how can you know where the orders are? Simple: Focus on the technical levels.

Perhaps no other currency pair is as beholden to technical support and resistance as USD/JPY. In large part, this has to do with the prevalence of substantial orders, where the order level is based on technical analysis. USD/JPY displays a number of other important trading characteristics when it comes to technical trading levels:

• USD/JPY tends to respect technical levels with far fewer false breaks. This situation is typically due to the presence of substantial order interest at the technical level. If trend-line analysis or daily price lows indicate major support at 118.20, for example, sizeable buying orders are likely to be located there. The bank traders watching the order may buy in front of it, preventing the level from ever being touched, or tested. If the selling interest is not sufficient to fill the buying order, the level will hold. On the other hand, if the technical level is breached, it’s a clear indication the selling interest is far greater and is likely to continue.
• USD/JPY’s price action are usually highly directional (one-way traffic) on breaks of technical support and resistance. When technical support or resistance is overcome, price movements tend to be sharp and one-sided, with minimal pullbacks or backing and filling (prices coming back to test the breakout level). This situation is the result of strong market interest overcoming any standing orders, as well as likely stop-loss orders beyond the technical level.
• Spike reversals (sharp – 20 to 50 pip price movements in the opposite direction of the prior move) from technical levels are relatively common. Spike reversals are evidence of a significant amount of market interest in the opposite direction and frequently define significant highs and lows. They’re also evidence that the directional move that was reversed was probably false, which suggests greater potential in the direction of the reversal.
• Orders frequently define intraday highs and lows and reversal points. Japanese institutional orders also tend to be left at round-number prices, such as 118.00, 118.25, or 118.50. When you look at charts involving JPY, always note tops/bottoms are close to round number price levels because there could be significant orders there.