If you want to be successful in Forex trading, you need to decide which currency pair to focus on. This decision will depend on a combination of factors, including your understanding of the pair, your trading strategy, your level of experience in the currency market, as well as your risk tolerance. In this article, we'll dive into one of the most popular and widely traded currency pairs: USD/JPY.
What is the USD/JPY?
The USD/JPY currency pair is a Forex pair that includes the American Dollar (USD) as the base currency and the Japanese Yen (JPY) as the counter or quote currency. If the USD/JPY is quoted 149.33, then that means that 1 USD = 149.33 JPY.
What should you know about USD/JPY trading?
If you anticipate a strengthening of the USD or a weakening of the JPY, you would opt for a long position, entailing the purchase of the currency pair. Conversely, if you expect the USD to weaken or the JPY to strengthen, you would take a short position, involving the short-selling of the USD/JPY.
It's worth noting that the USD was involved in 88% of all FX positions, as revealed by the latest OTC foreign exchange turnover report by the Bank for International Settlements (BIS) in 2022. Following closely behind was the euro (EUR) at 31%, with the JPY accounting for 17% of all transactions.
These figures underscore the dominance of the USD in the global foreign exchange market alongside the EUR and JPY.
This dominance is not surprising given that the USD represents the world's largest economy, the United States, bestowing significant economic influence and rendering it an attractive currency for trade and investment. The stability of the US financial system and the liquidity of USD-denominated assets also contribute to its allure for global investors.
Furthermore, the USD holds a primary role in international transactions and it serves as a reserve currency for numerous central banks, further solidifying its status. The American Dollar is also the most popular currency in the commodity market.
Trading Hours of the USD/JPY
While the Foreign Exchange market is always open during the week, each currency pair will gather the highest trading volume and liquidity during its relevant trading sessions.
In the case of USD/JPY, the most important trading sessions will be the Asian Forex session, also known as the Tokyo session, from 11 pm GMT until 8 am GMT, and the American session, also known as the New-York session, from noon to 8 pm GMT.
8 things to know about the American economy and the USD
- The United States is the biggest economy in the world based on Gross Domestic Product (GDP).
- The US is the second biggest global exporter after China.
- Canada, Mexico, and the European Union are the top three US export partners, followed by China, Japan, and the United Kingdom.
- The US is the largest importer of goods from China, the European Union, Mexico, Canada, Japan, and Germany.
- The country is the largest service exporter with the European Union, Ireland, the United Kingdom, Canada, Switzerland and China being the most important purchaser of American services.
- It is also the largest service importer in the world, especially from the European Union, the United Kingdom, Germany, Canada, Japan and Mexico.
- The US has trade relations with more than 200 countries and territories.
- There is a negative correlation between the USD and most commodities priced in USD, which means that they move in opposite directions. When the USD loses ground, commodity prices tend to rise, and vice-versa.
7 things to know about the Japanese economy and the JPY
- As Japan is an exporting giant, the country heavily relies on exports.
- The most important Japanese exports are cars, integrated circuits, motor vehicles, parts and accessories, machinery, and photos lab equipment.
- The top Japanese exporting partners are China, the United States, South Korea, and Thailand.
- The major imports of Japan are related to petroleum and gas from China, the United States, Australia, and South Korea.
- The value of the JPY strongly impacts the level of the country’s exports (negative correlation).
- There is also a negative correlation between the JPY and Japanese stock indexes.
- Favorite currency for currency carry trade operations.
Using Fundamental Analysis to Trade the USD/JPY Forex Pair
Fundamental analysis with currency trading is all about finding out the intrinsic value of a currency pair based on economic conditions in the related country.
The better a country’s economy, the stronger a currency, as it means that more investors will invest money in that country. Therefore, foreign investors will need to buy this country’s currency to invest in local currency, increasing demand for the given currency and pushing its value higher.
On the other hand, when a country's economy is struggling, its currency tends to weaken, as investors tend to withdraw their investments from the country, reducing the demand for its currency.
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Economic Indicators
To determine the strength of an economy and its growth prospects, Forex traders need to take into consideration social and political forces, as well as economic indicators, such as growth, inflation and employment figures among others, such as GDP, CPI, PPI, PCE, unemployment rate, JOLTS, NFP report, etc.
There is a popular trading strategy using news releases called news trading, in which Forex traders take advantage of higher trading activity and volatility before and after a news release to make short-term trades.
Traders may choose to enter a position either before an economic news release in anticipation of price movement, or immediately after the release to capitalize on the reactions of other market participants, depending on their directional biases.
👉 Read our guide on News trading best practises
Monetary Policy
Economic indicators also hold significance for central bankers as they provide insights into the strength of a particular economy and are useful in their decision-making process regarding adjustments in their monetary policy needed to achieve set goals, typically including full employment, 2% inflation, and sustainable growth.
When a central bank decides to lower or raise interest rates, it impacts the potential returns on investments denominated in that currency. This adjustment in interest rates can lead to either higher or lower yields compared to alternative currencies, emphasizing the importance of interest rate differentials between two currencies in deciding in a currency pair direction.
👉 Read our guide on The role of central banks in Forex markets
Forwards Guidance
Forward guidance from central bankers is helpful for investors and other economic agents like households and businesses to make their financial decisions, as it usually refers to the communication from central banks’ officials about what they intend to do regarding monetary policies and what their overall economic outlook is.
Central bank guidance plays a crucial role in shaping market expectations and impacting financial conditions. This guidance can manifest in various forms, including official statements, addresses by central bank representatives, press briefings, and published reports.
Currency Carry Trading
Guidance enables investors to forecast shifts in monetary policy, allowing them to add currency carry trades in their strategy. This involves borrowing funds in a currency with low interest rates and investing them in a currency with higher interest rates.
The objective is to mostly capitalize on the interest rate differentials between the two currencies, while also potentially gaining from any appreciation in the higher-yielding currency compared to the lower-yielding one, to a lesser extent.
Japanese and American Monetary Policy and Currency Carry Trades
Recent communications from Federal Reserve (Fed) officials have presented a mixed outlook. While some have dampened market optimism regarding potential interest rate cuts, others have affirmed the likelihood of such reductions, albeit with possible delays. This conflicting messaging can create uncertainty and market volatility as investors grapple with deciphering the direction of monetary policy. Currently, interest rates remain within the range of 5.25% to 5.50%.
The Bank of Japan (BoJ) has adjusted its policy by allowing higher long-term bond yields since December 2022, while maintaining its benchmark interest rate at -0.1% in its last meeting. This negative interest rate policy, implemented in 2016 to spur economic growth and combat deflation, aims to stimulate borrowing and investment while discouraging saving. However, it also poses challenges such as reduced bank profitability and impacts on savers and pension funds. Although the BOJ has not set a clear timeline for ending negative rates, most analysts anticipate policy normalization in the first half of 2024.
Given Japan's prolonged negative interest rates, the Japanese Yen has been popular in currency carry trades, where investors borrow JPY to invest in higher-yielding currencies. The US Dollar has been particularly favoured recently due to the Fed's aggressive rate hikes, reaching its highest level in over two decades.
Investors with a higher risk tolerance are turning to emerging markets like Colombia or Turkey, where interest rates are much higher at 12.75% and 14% respectively. However, these trades carry greater risk due to political and economic instability.
👉 Read our guide on Should you anticipate interest rate cuts or a status quo on interest rates in 2024?
Using Technical Analysis to Trade the USD/JPY Currency Pair
Technical analysis is a popular way of analysing the markets, which relies on historical price and volume to determine the current trend and anticipate the direction of a financial instrument (upward, downward or flat).
There are many different types of technical trading strategies you can use when trading Forex, depending on the trading styles you want to use (scalping, day trading, swing trading, currency carry trade…).
Even though your choice should always be made after you’ve determined the kind of Forex trader you are and based on your trading experience and knowledge, your risk-tolerance, and your trading goals, let’s have a look at two common strategies used in Forex trading - trend trading, and breakout trading.
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Trend Trading
Trend following strategies are based on the general direction of an asset and the assumption that the primary trend is likely to continue. Traders are usually therefore aiming at catching a long-lasting move.
Traders focusing on the USD/JPY will open long positions if they spot a bullish trend (meaning that the USD/JPY is moving upward). On the other hand, they will open short positions if they spot a bearish trend (meaning the USD/JPY is moving downward).
Moving averages, Parabolic Stop and Reversal (Parabolic SAR), Average Directional Index (ADX), trend lines and canals are the most popular trading tools and indicators used in trend-following strategies.
Breakout Trading
Forex traders use breakout strategies when they intend to catch the price acceleration or strong momentum after a range, a chart pattern, or a support/resistance breakout and take advantage of the initial stages of an upward or downward movement.
Usually, breakout traders will open a long position when the USD/JPY breaks above a resistance level, which acts as a ceiling for the prices. Conversely, they will enter a short position if the USD/JPY breaks below a support level, which acts as a floor for the prices.
To be significant, these price movements need to be done with strong momentum and trading volume. While some traders will enter the market as soon as the breakout occurs, others will wait for prices to move towards the key price level to open their positions - this is called a pullback.
👉 Read our guide on Should you use short-selling in your trading?
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