A textbook resistance trade in the euro

Just before I start today's email, I'd like to say many thanks to all of you who attended my talk at the MoneyWeek conference last week for your terrific feedback on my blogs. It was great to meet you all.

If you didn't manage to get hold of a ticket, you can find out how to get a recording of the whole conference, including my talk along with others from James Ferguson, Merryn Somerset Webb and Dominic Frisby, here.

And now let's get back to where we were in the EUR/USD market.

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Last Friday (17 June), when I left it, the EUR/USD had retraced to the Fibonacci 76.4% level: The importance of a good support level in a fast-moving currency trade, where I suggested there could be a bounce to correct the very short-term oversold momentum reading.

I said that if I were a short-term trader I could be taking profits on a short position there.

I also said that if I saw an A-B-C (three-wave) bounce up to the overhead resistance area at the 1.4330 on wave C, that could be a good place to short again.

Here is this Monday morning's chart:

(Click on the chart for a larger version)

As we can see, the market followed my script in textbook fashion, with a rally to this overhead resistance (on overbought momentum shown with my purple box), and then a good move down, which is continuing this morning as I write.

Let's zero in on this move:

(Click on the chart for a larger version)

Now with the A-B-C rally complete, I can draw some tramlines. Connecting the Thursday and Friday lows, that gives me my lower tramline.

Then I can draw a parallel line using my parallel tool on my spread betting platform, and I find the upper line passes through the wave C high and also passes through the minor tops of last Wednesday/Thursday.

That makes the tramline pair a good working hypothesis.

If that is so, because the tramlines are lines of support and resistance, I can expect a drop to the lower line to be where a possible bounce starts.

So, a short trade taken at wave C could be covered when the market drops to my lower tramline.

And this morning, the market has made it to my lower tramline for a decent 200 pip short-term profit.

But what will happen next?

But now what? Will the market stage a good bounce, or will it just plunge through my lower tramline?

Most traders face these kind of questions! And they are impossible to answer with any confidence!

All we can do as traders is to posit scenarios, and here are some:

1. If the market falls through and challenges the low of wave B, a good policy would be to place sell-stops just below wave B to re-enter. The odds would be that the downtrend had resumed. Protective stops could then be entered using my 3% rule;

2. Or if the market does stage a good rally, it might rally to my upper tramline again, and I would be looking to short again;

3. Or it might trade in a narrow range for a long time and not offer any decent opportunities for short-term trading;

4. Or if I have a long-term view and I want to enter wide stops (still using my 3% rule!), I could enter at any time and walk away.

My view at the moment is that a bounce from here is in order, if only because my tramlines have proven themselves to be formidable lines of support. Also, the mood has suddenly turned negative on the euro, and that is often a reason to suspect a pause in the trend.

The markets seem perverse when you start studying them, but they do follow their own logic.

This logic is contrary to the kind of logic we use in everyday life, which is why Joe Granville's maxim is so true: "When most people think it is obvious, then it is obviously wrong".

How very zen!

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