Today, I want to follow up on the euro story because it is demonstrating the sheer profit-making power of using the basic Elliott wave concepts that are embodied in my tramline trading method – the same system I teach in my Trade for Profit Academy.
On 18 July, I outlined my case to expect a sharp fall in the EUR/USD rate. This was based on the Elliott wave labels I placed on recent action.
Basically, from the 1.40 key reversal high on 8 May, I could count waves 1 and 2 and concluded the market was at the start of wave 3.
This was the chart then:
It shows the very steep decline off the 8 May top to my wave 1 low, then the rally in wave 2 and the decline in a budding wave 3. Remember, third waves are invariably long and strong. In fact, that is their signature. If you see a market move rapidly with few set-backs, you are probably in a third wave of some sort.
Note also the lower wedge line had been broken, which gave a sell signal.
Not only that, but there was a smaller scale wave pattern developing. This was the hourly chart I showed:
The break of the lower green wedge line and the lower tramline were also short-selling triggers.
The market was then testing the pink chart support and in two third waves down.
Where we are today
This is the situation this morning:
Right on cue, the pink support zone was broken to confirm my ‘third of a third’ forecast.
Already, all of the short trades taken on the above signals are in profit.
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The bigger picture
Let’s now back up and check where the market sits in the bigger picture. It is so easy to keep your focus on the short term that important developments in the bigger picture can be missed. You are then not seeing the wood for the trees!
Here is the daily chart:
The run-up in the C wave occurred on weaker momentum highs, which warned of an impending reversal which was made at the 1.40 level.
Now, with the break of my lower wedge line, the market has broken the Fibonacci 23% support (which was where my large wave 1 bottomed). It is now heading for the next Fibonacci support at the 38% level in the 1.3260 area.
The 1.3260 level now becomes my first major target.
But of course, markets rarely oblige by heading directly for a target in a straight line. We must expect some rallies along the way.
Will there be a relief rally?
One input I use for assessing the likelihood for a major relief rally is the commitments of traders (COT) data. My general rule is this: if the speculators are heavily net short, I can expect sharp rallies. And if they are evenly balanced or even net long, rallies are usually brief and small.
The latest COT figures are over a week old (the latest data is released today and every Friday for a snapshot as of the previous Tuesday).
|CONTRACTS OF EUR 125,000||Open interest: 310,661|
|Changes from 07/08/14 (Change in open interest: 16,280)|
|Percent of open interest for each category of traders|
|Number of traders in each category (Total traders: 191)|
This data shows that the large specs (non-commercials) are about two-to-one bearish, since they hold about twice as many short futures positions as long. The small specs (non-reportables) are slightly more bearish with a ratio of 2.2 short to long.
Remember, the specs are the most price-sensitive cohort. The commercials (banks, trade houses, large exporting companies) are far less price sensitive because they are usually passing risk onto the specs by their hedging activities.
This means that any adverse move in the market would probably cause many specs to cover their shorts, thereby extending rallies by their short covering.
This data tells me that the market is vulnerable to short squeezes and to expect significant relief rallies.
Also, a glance at the above chart shows the bull move off the 2012 low was a choppy affair with large swings both up and down. I have no reason to suspect the descent to be anything different. I am therefore prepared for major rallies.
But is there just such a rally imminent?
Is a reversal near?
Back to the hourly chart and to look for tramlines.
Remember, tramlines are a basic building block of my trading method. I have a superb lower tramline with a great prior pivot point (PPP) at the 1.37 high and multiple touch points, making it a very reliable line of support.
My upper tramline is speculative at this stage with the messy overshoots around 13 July.
But the key observation here is the large positive momentum divergence at yesterday’s low, which was a spike move right to my lower tramline support. When I see such a divergence coming after a strong move to a lower tramline, I suspect a reversal is at hand.
That is why I decided to take partial profits on my short-term short trades on the spike move below 1.3450. But the larger trend remains down and rallies are to be sold (until proven otherwise).
And if a relief rally emerges here, I will be applying my Fibonacci levels to forecast where a rally would likely terminate.
If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together