Did you find the path of least resistance in EUR/USD?
John C Burford outlines a trade in the euro vs the dollar in the wake of the US Federal Reserve’s most recent announcement.
On Wednesday, I set a small exercise in EUR/USD based on the lessons provided by the previous two European Central Bank (ECB) interventions in December (D-Day 1) and the one this month (D-Day 2).
To recap, I found that EUR/USD rallied hard after those two interventions that were intended to weaken it. This seemingly perverse result stemmed from the bearish sentiment towards the euro leading up to the two D-Days.
With this recent history on my side, what were the odds of a similar result on Wednesday evening when the US Federal Reserve was to announce its intentions regarding plans for its monetary interventions?
If the Fed expressed a "dovish" forecast for interest rates, would we see a similarly perverse result with the dollar risingand EUR/USD falling? The market certainly expected Janet Yellen to give a firmed-up guide to the timing of the four 0.25% rate rises she had promised last year.
Just before Wednesday, there was a heated debate among Fed-watchers over how many rises she would announce and their timing, but the general feeling was that there would be some timetable laid out.
In the event, there was nothing of the sort. It was all wishy-washy Fed language and that meant most pundits were disappointed. And with no rate increase timetable, the dollar fell this time in a rational reaction.
So history did not repeat itself with a third "perverse" market move. But the rally in EUR/USD was set up beforehand anyway!
This was the hourly chart just beforethe Fed announcement on Wednesday:
The big rally on D-Day 2 took the market to the 1.12 area and from there the market consolidated its gains inside a very lovely wedge.
Note the pattern inside this wedge it is a textbook five-wave affair with a solid lower support line and solid upper line. This type of wedge pattern often denotes a consolidation phase following a sharp move, and that implies a probable extension to the rally near-term in a vigorous thrust.
So there was a potentially profitable trade by going long. But because I only look for high probability/low-risk trades, I have a natural entry point. That is to enter on a buy-stop order placed just above the upper wedge line. I could have entered that order well before Janet was to speak and potentially shake up the market from its slumber.
To me, this was the path of least resistance. But if wrong, then the market would sell off and most likely not penetrate above the wedge line nor touch off my buy-stop. No damage would result. Remember, part of a successful campaign is not losing money.
Of course, the market did rally hard past my entry buy-stop and I was in with a long position. This is the updated chart:
In less than two days, the market rallied by around two cents and this rally could be my C wave of an A-B-C correction to the main trend (down). So is this a good place to take profits?
For one thing, there is the huge momentum divergence staring me in the face. That signals that wave C is weaker than wave A, which is entirely typical for a C wave. A weaker wave means that buying pressure is waning and a reversal could be approaching.
But also, wave C is a Fibonacci 62% multiple of wave A at the 1.1310 area and this is a very common wave relationship.
Odds are stacking up that I have found the top of wave C.
How are these short-term waves fitting into the bigger picture. Here is the daily chart showing my tramlines:
The market first broke below my lower tramline in October and since then has been struggling to get back to it and finally succeeded in planting a kiss last month. And from there, the market went into a traditional and violent "scalded cat bounce" down.
The current rally has produced a high momentum reading from where previous tops were put in. Further gains appear unlikely in the short term.
But now with the market attempting to get back to the line, will it succeed? My short-term goal has been reached, and I am content to bank some profits and await developments.