AUD/CAD - Shoulder, Head, Shoulder?

AUD/CAD - Shoulder, Head, Shoulder?

Since the second week of October, the AUD is up 5 big figures (more than 5%) against the CAD. Given both currencies are considered commodity currencies, and have many similar macro drivers, this is a significant move. An evolving approach to one of the best known chart patterns, the "head and shoulders", suggests it may be time to sell AUD/CAD.

Fundamentals may be in play here. Australian short rates are 3.25%, compared to Canada's 1.0%. "Safe haven" flows may also explain the AUD strength. Central banks around the globe appear to have recently discovered Australia's AAA rating, while Canada's location in the northern hemispere put its AAA rating on their radar some time ago.

However, its the technical factors that suggest this one may be turning.


Source: CMC Tracker

Its clear the up trend is broken (orange line). Note the resistance (black lines) and the potential head and shoulders formation ("neckline" in blue).

One of the features of markets since the GFC is the number of false signals from charts, particularly where the signal or pattern is well known. This may reflect market positioning. As more traders and investors act on a chart indicator, it can sometimes mean there is no further interest once the siganl is triggered - resulting in a reversal.

While technical signals are still useful to traders, and trading discipline can limit the impact of false signals, some traders are "evolving" in their use of signals. This is an example of that "evolution".

You can see on the charts we have a left shoulder and head. The price is possibly tracing the right shoulder, confirmed if the price now drops to the neckline, around 1.0330. Traditionally, traders enter a sell trade at the breach of the neckline, looking for a substantial fall, as this is a trend reversal signal.

However, I'm taking a different approach. By selling now, with a tight stop loss just above resistance at 1.0392, I'm anticipating the pattern completion. If AUD/CAD breaks the neckline as expected, I immediately move my stop loss order to 1.0330. This means if the signal is false, instead of taking a loss, I book a small profit, making my head and shoulders trading more sustainable. My reward to risk on the anticipatory trade is just under 2:1, and if the head and shoulders signal is true, my reward to risk improves enormously.

This puts me in the following trade:

Sell AUD/CAD at 1.0375, stop loss above 1.0392. Move stop loss to just above 1.0330 on breach.

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