Here are the Reasons why the Japanese Yen Could Bounce Sharply

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1. The Dollar has broken substantial resistance versus the Yen, but early sign of USDJPY turn is clear warning

2. Strong link to the Japanese Nikkei 225 leaves the domestic currency at risk into year-end

3. Our retail forex sentiment-based Momentum2 system strategy has now sold USDJPY and GBPJPY

US Dollar/Japanese Yen at Longest Consecutive Streak of Gains since January

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Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

1. The USDJPY is at its longest win streak since January. Such a level has coincided with important turns in the past 7 years. Our Senior Technical Strategist further points out key risks of an outside-day reversal in the USDJPY.

Strong Correlation between Japanese Yen and the Japanese Nikkei 225 leaves USDJPY at Risk

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2. The strong link between the Japanese Yen and the Nikkei 225 suggests that the next major JPY move will happen on similar price action out of Japanese stocks. The Nikkei has surged towards year-to-date peaks, but it’s important to note that the index is coming up on major long-term trendline resistance.

It’s likewise worth noting that Japanese investors could sell holdings ahead of January as the domestic capital gains tax rate is set to double in 2014. The timing of any selling—if it does occur—is not obvious.

Yet it’s difficult to ignore the risk of a pullback given that the Nikkei 225 is up nearly 50 percent on a year-to-date basis.

Japanese Nikkei 225 Index is Testing Resistance Dating back to 1991

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Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

3. A noteworthy shift in retail forex positioning has led our Momentum2 trading strategy to sell the USDJPY and GBPJPY for the first time in a month. And though there’s obvious risk that this is a minor correction within a much larger uptrend, the early turn in retail trader sentiment adds weight to calls for a potential JPY reversal.

Retail forex trading crowds are now their least short the GBPJPY since the start of November

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Source: FXCM Execution Desk Data

It will be important to watch the next moves in crowd sentiment. Traders remain heavily net-short the GBPJPY and similarly short USDJPY and EURJPY. We typically use our proprietary Speculative Sentiment Index data as a contrarian indicator to price action: if everyone’s short we prefer being long and vice versa.

Yet early signs of a shift alongside key technical and fundamental risks underline the potential for a Japanese Yen bounce (USDJPY pullback).

Follow any updates on the Japanese Yen via this author’s e-mail distribution list.

Forex Correlations SummaryView forex correlations to the S&P 500, S&P Volatility Index (VIX), Crude Oil Futures prices, US 2-Year Treasury Yields, and Spot Gold prices.

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Data source: Bloomberg. Chart source: R SEE GUIDE ON READING THE ABOVE CHART

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.

Contact and follow David via Twitter: https://twitter.com/DRodriguezFX

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.
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