Today, I want to show you an interesting setup in the EUR/USD that illustrates how drawing in the third tramline can be invaluable in setting price targets.
On 11 August, I asked the question: Is the euro ready for a rally? This was the hourly chart then:
I then combined the tramline break on this hourly chart with the longer-term daily chart:
It showed major chart and Fibonacci support, and I concluded that a rally was very likely.
The euro stages a rally – but it was weak
The market did rally, but the rally was very weak when it hit my third tramline.
The tramline break was the initial signal that a rally was in the offing, and on that break I could draw a third higher tramline. That is always my practice whenever I see a tramline break. The reason is that my new third tramline gives me a likely price target.
So how far did the rally carry? Here is the updated chart:
Actually, it didn’t carry very far. Although my third tramline target was hit, the high reached was only a handful of pips above entry price. This was because my tramlines have a sharp angle down and it did not take long for the third tramline to decline to the region of the entry price.
How to find a new target
Now that the market is making fresh lows, where is my new downside target?
Let’s take a step back and look at the daily chart:
From the 1.40 high, the pattern has a distinct three-wave feel to it (so far) in a possible a-b-c. The next Fibonacci support lies just below the current market in the 1.3250 area. That is one possible target.
Also, we often see wave equality between waves a and c. That would place wave c low at the 1.32 area.
But let’s look at my c wave in close-up:
I have a lovely five-wave impulsive pattern. The new low yesterday has confirmed the pattern. I can also draw in new tramlines.
My waves 1, 2 and 3 are textbook waves with wave 3 containing its own clear five sub-wave pattern. My wave 4 is complex, as is usual, and now we are in the final fifth wave down.
The complex wave 4 is interesting and forms a wedge, which is a typical pattern for a fourth wave. The 1.34 – 1.3450 area was solid resistance and every time the market tried to break free, it was hit by heavy selling. And just like a coiled spring, the move out of the wedge is sharp.
That is one thing you can reasonably forecast when you see a wedge and that is why it is one of my favourite patterns. A trade in the direction of the breakout will usually be in profit from the get-go. I like those trades!
The equality of waves 1 and 5 gives me another target
Now, using my new tramlines, I have a possible target to the lower tramline in the 1.32 region.
But there is also another wave equality rule I can apply here: the equality of waves 1 and 5. That would place the target at the 1.3270 area. Of course, the fifth wave could extend, but as a minimum the 1.3270 level appears valid.
I now have five downside targets from several different methods:
• Wave 1 = wave 5 of c wave: 1.3270
• Fibonacci 50% support: 1.3250
• Centre tramline on hourly: 1.3250
• Wave a = wave c on hourly: 1.32
• Lower tramline on hourly: 1.32
They all lie between 1.3270 and 1.32, making that a prime target area.
Of course, we could really be in a large third wave of an impulsive five-wave pattern off the 1.40 high, not an a-b-c. If so, the downside target for wave 3 lies much lower than 1.32.
Further market development will help answer than question. But at least I have some firm targets where I can consider taking at least partical profits using my split-bet strategy.
What the sentiment data tells us
But there is one other factor to consider – the COT (commitments of traders) data, which shows how bullish or bearish the specs are. And last week’s data shows that the hedge funds are still more that three-to-one bearish, while the small specs are a little over two-to-one bearish.
That tells me that when the fifth wave completes, I should expect a decent relief rally (in perhaps an A-B-C pattern).
For short-term trades, the 1.32 region appears a sensible place to take at least partial profits.