Sometimes a fundamental idea becomes an idea for a trade for many retail traders.

@lilac proposed the following:

“GBPJPY is worth a good squint at now – Vodafone had a reasonable day today after Japan’s Nikkei suggested Softbank have got their eyes on them.”

Vodaphone is British
Softbank is Japanese

If Softbank buysVodaphone, that would require buying of GBPJPY at some point as Softbank sells JPY for GBP to pay Vodaphone.

Of course, I don’t know if that deal will happen. @Lilac does not know. Even if it is true, we don’t know when it might happen. It may be next week, it might be 3 months down the road, it might be never.

So personally, trading that story does little for me. I cannot define my risk on that story. It may turn out to be true and I can go tell all my buddies how I made a killing on the GBPJPY on a hunch Softbank was going to buy Vodaphone, but honestly, it would be 100% LUCK. It may never happen and the GBPJPY trades down for other “reasons”.

Can I still do a trade just in case @lilac has something there?

What might make me interested, is if I had a “squint” at the GBPJPY and could find some risk defining level that might make sense and allow me to benefit if the story were to be true in the “near term”.

GBJPY daily chart shows that the price bounced off the 200 day MA twice in August. Support held.

GBJPY daily chart shows that the price bounced off the 200 day MA twice in August. Support held.

Looking at daily chart of the GBPJPY what do we see?

I see two separates tests of the 200 day MA in August (the green line in the chart above). I also know that the price of the GBPJPY has not closed below the 200 day MA since November 2012. Yes that is 2012.

If the price stays above the 200 day MA is that bullish or bearish? The answer is: Bullish
If the price moved below the 200 day MA is that bullish or bearish? The answer is: Bearish.

There is the line in the sand or the “borderline” between bullish and bearish regardless of the “news”. That level comes in at the 200 day MA. That theory was tested twice in August.

The current 200 day MA is at 171.20. The current price is 172.36.

The question for the traders who like the GBPJPY and want to use the 200 day MA as support is this: “Would you risk 116 pips on that idea?”

If yes and you want to apply 3% of your account balance to that trade, calculate what that is and figure out the position size that would limit your loss of 116 pips to 3%.

To do that let’s assume:

Account Balance = $10,000
3% risk x $10,000 = $300

If the value of a pip on 1 lot of GBPJPY is currently $9.35, 1 standard lot with a 116 pip loss would equal:

116 pip max loss x $9.35 = $1,084.60.

That amount is what you would lose with 1 standard lot. If you can only lose $300 max on the position or 3% of your account, the size of the position should be smaller. The actual position should be:

$300/1084.60 = .2765 of a lot or 2.8 mini lots

So if I were to do that trade, off of the fundamental idea that Softbank was going to buy Vodaphone and the GBPJPY would go up, I could define and limit my risk by using the 200 day MA as my stop.

What is the potential reward?.

Looking at the same chart, if the 200 day MA is not breached where could the price go to? No one knows but we do know that the targets technically would be:

  1. The high from March at 173.62. Is that possible? Yesterday we were at that level. So Yes. If the price were to go there we would have a gain of (173.62- 172.36 or 126 pips). The reward to risk would be greater than 1:1
  2. The high from yesterday at 173.94. Total profit = 158 pips. The reward: risk would be 1.36:1
  3. The high from January at 174.80. Total profit = 244 pips. The reward:risk would be 2.10:1
  4. The high for the year at 175.35. Total profit = 299 pips. The reward/risk would be 2.58:1

What are the chances of getting above the 175.35 high. The market was last there at the beginning of July or two months ago. It is not out of the question.

Other than this idea that there may be a merger, what has been driving the GBP and the JPY. In the UK the focus is currently on the Scotland referendum. Discounting that the fundamentals in the UK are more positive.

In Japan, the JPY has been hit on expectations that the BOJ will need to ease down the road.

Can those fundamental influences change? Yes.There are a lot of things that can change the fundamental picture. The US employment report can be an influence. The stock markets can be an influence. Interest rate spreads can be an influence. Geopolitics can be an influence. There are a lot of unknowns that can be an influence.

What is constant is the 200 day MA. As long as the price stays above the bias is bullish and risk is defined and limited. As soon as it goes below, we make the assumption, the price will go down and we take a loss equal to 3%.

Ideas are good in that they can influence our bias (I prefer to buy/I prefer to sell), but they do not define risk or tell you when you are wrong…

Thanks to @lilac for the stimulation for this post!!