 Dynamic Topping Patterns Emerge in Euro
by Kevin Pendley
In this week's column, we're going to delve hard and fast into the world of technical analysis as a directional trading key for trends in the euro/dollar FX market. Let's make this clear right off the bat: I never consider a trade - no matter how compelling the fundamental argument - without being comfortable with the chart structure first. Before chart study was even prevalent in market analysis some two decades ago, a brilliant trader shared this nugget of wisdom with me: "If the fundamentals say one thing and the charts say another, go with the charts. They are right far more often."
The euro/dollar pair, easily the most heavily traded currency market in the world, sports a powerful double top on weekly charts that provides nice validation that an important long-term top or major downside correction is at hand.
The euro/dollar pair, easily the most heavily traded currency market in the world, sports a powerful double top on weekly charts that provides nice validation that an important long-term top or major downside correction is at hand.
Short euro trades have been a dominant theme on this weekly FX report, and given the dramatic chart structure in play right now, I feel compelled to return to this market again this week. As you can see by the attached chart, a beautiful double top pattern has been carved out during this week's test of the recent bounce highs. A double top emerges when the market tests an important high and finds sellers to reject that price zone. I consider double tops to be one of the more convincing chart formations that you'll ever encounter, and they gain validation when price action in the wake of the double top provides followthrough directional bias.
Even more compelling is that this week's double top pattern fits perfectly in the shadow of a key bearish outside reversal that was generated when the market rejected new all-time highs back in mid- to late-April. The wonderful part about timing is that this FX column was initiated right when those highs were made, and the first trade recommendation we issued was a short euro position. If you managed to take profits on the first powerful wave down off that April peak, or ride out the recent bounce (our protective profit stops were hit), then you are holding an attractive winning effort on the currency market. From our initial sell-side entry on the euro/dollar pair, the market is down some 180 pips, or about 1.1% in value.
The emergence of this week's dynamic topping formation on weekly studies suggests that further downside action is likely in the euro in the weeks to come. If that scenario does play out, then it would hint that a bottom in the U.S. dollar is likely. In addition, the euro remains a great short on chart patterns versus the Canadian dollar. Although the picture is not as commanding against the yen, the fundamentals in play still support finding the right entry spot to try short euro/long yen trades again at some point.
Short positions in euro/dollar from current values near 1.5525 make sense, with any push back toward the double top peak at 1.5640 a warning that the bulls made a stand. From a target standpoint, if you are a long-term investor, then the first big objective would be near 1.5000, which would be a massive move that could take several weeks to play out. Along the way, the recent corrective low at 1.5283 could offer an important test to see if the market has indeed turned. Ideally, this week's double top will find immediate confirmation early next week via further downside probing. A rally even through 50% of this week's pullback range (currently near 1.5600) would jeopardize the double top formation.
Let's talk a little bit about formulating long-term profit objectives for those of you who caught the big decline in euro/Canada that we recommended a few weeks ago. On the attached chart, I have pointed out Fibonacci retracement lines drawn off the entire bull market run in euro/Canada from the bottom last winter to the top this spring. The first objective comes in at 1.5168, which corresponds to a 38.2% retracement move. That area also fits nicely with traditional chart support because it matches an area of resistance from the January 2008 highs. When Fibonacci levels correspond with important chart support/resistance lines they gain prominence. If you are holding multiple entries on the short euro/Canada trade, you can take profits on one-third to one-half of that position approaching the first Fibonacci target and then re-evaluate the rest of your position once you see how the market reacts to that price zone. I realize that my desire to protect profits sometimes slices my gains prematurely (see the euro/dollar rec), but I would much rather protect gains than watch losing trades run away from me.
FX COLUMN TRADE CONCEPT RECAP
DATE CONCEPT PRICE THEN/NOW PROFIT/LOSS COMMENT
4/24/08 Short euro/dollar entered @ 1.5682 +0.52% stopped out at 1.5600
5/01/08 Short euro/yen entered @ 161.50 +0.12% stopped out at 161.30
5/08/08 Short euro/Canada 1.5680/1.5315 +2.32% hold; stops at 1.5510
5/15/08 Short euro/yen entered @ 162.40 -0.36% stopped out at 163.01
5/29/08 Short euro/dollar entered @ 1.5525 NA stops @ 1.5610
out at 163.01
Kevin Pendley has been involved in financial and commodity markets for two decades, including more than 15 years with Knight-Ridder Financial News/BridgeNews. In addition to his work at 4xAdviser.com Weekly, he is a contributor at SmallCapInvestor.com where he writes a weekly technical analysis column on the Russell 2000.
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