A potential pairs trade opportunity in USDYEN v Nikkei

When we were suggesting to short the Nikkei (in the face of my ol pal Caawky & Mr “Big Call” John Piper’s long calls) 2 weeks ago at levels between 14500 – 16000 the retort I received from pretty much everyone I bounced it at was  – “are you mad, it’s all about the Yen”, “why short while the yen goes lower” etc..?

They were right, it was all about the Yen and as we can see on the chart below, the Nikkei, in the last 2 months, got massively out of kilter with the underlying yen weakness – it deviated by some 16%. Last week, the Nikkei completed its swing to the other side, undershooting the Yen by around 6%. 

We think there is a pairs trade opportunity to go long the Nikkei and short the Yen (in equal gross notional proportions) should the deviation move back out to around 5-6% between the two. NOTE – We would not play the pair on the other side, ie short Nikkei v long yen unless the deviation hit 12-13%.

We sit in lair waiting for another divergence between the two…

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