Risk Appetite Returns & Associated Chart Patterns

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Risk Appetite Returns & Associated Chart Patterns

Postby bforex » Mon Apr 26, 2010 10:48 am

The Dollar Yen trade, also known as the ?Carry? has become a measure for risk appetite. There are several types of buyer in the market. You have buyers who believe what they are buying will appreciate and you have those who borrowed, or shorted a currency and now wish to buy it back to cover their short. Regardless of the reason, buyers drive price appreciation. However, buying to cover, is vastly different from buying to hold. Buying to cover is a means of removing risk from one's portfolio whereas shorting is a statement of risk taking, or reentering ones original position. Very often, when a reversal in sentiment occurs in a short time period, a chart pattern develops to help guide a trader with respect to entries and exits. On the chart below we see risk aversion followed by buyers returning to the market as they view the market to be oversold. Risk taking returns to the market and sellers create new weakness (in the JPY) as traders rush to get back into their original position. What we just described is a pattern known as a Head & Shoulders formation.

Commodities recently have been a great measure of risk aversion, especially when looking at the headline commodities such as Oil and Gold. The reason for this is the Global Economy. Whereas, years back true Demand that effected supply was limited to a number economies. As the Global Economy emerged and economies grew so did the number of Countries that impact bottom line demand. As investors try to anticipate what true demand will look like as we pull out of the global recession, traders are betting on higher commodity prices for the future.

Oil is one place where we see risk taking and risk aversion sentiment in the market place emerge. If we look at Oil on a 1 hr chart as shown below, we observe a similar pattern in price action as with the JPY. An inverse Head & Shoulders pattern forms with the Head representing the peak in risk aversion while a break above the neckline demonstrates that market risk taking sentiment has returned.

It used to be that Gold was a very conservative investment. It could be used as a hedge against inflation. Gold also was the asset of choice when economic turmoil struck. Due to its universal demand it was deemed a safe conservative investment, but one that only saw real gains when risk aversion was high. Today, Gold no longer trades solely in that fashion, rather it trades more like any other commoditized product. Although the same Head & Shoulder pattern did not form, as Gold did not sell off as quickly as Oil and the JPY, never the less, you can follow a similar market risk sentiment pattern. One pattern that candle chartists look for are long wicks. The daily chart below highlights a few cases where a long wick in the prevailing market direction signal imminent reversals.

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