The euro follows my market roadmap

On Friday, I outlined the many reasons why I expected a significant high in the EUR/USD at the 1.38 level. It could even turn out to be a major high, which may not be breached for a long time. We shall see.

It is interesting to examine the psychology behind a rally at that level. This has to be done in the absence of updated COT (commitment of traders) data, which are still unavailable many days after government officials have returned to work.

The latest rally off the July low at the 1.28 area was centered on the belief that the eurozone economy was finally turning a corner, and that the European Central Bank was still showing no signs of starting their own quantitative easing programme, which would inevitably put pressure on the currency.

On the other side of the cross, the dollar was under pressure because of the negative mood surrounding the government shut-down, as well as the fractious debt ceiling drama, which once again highlighted the ballooning US national debt.

If you read the financial press and the many comments on blog posts, you will notice that a large cohort of the US public have an extremely negative attitude towards the dollar. But, then again, maybe it is only the doom-mongers that comment on blog posts.

This negative sentiment induced the large speculators, the hedge funds, to take an aggressive long position on EUR/USD. The last COT report of 22 October shows a ratio of over two-to-one large speculators were bullish.

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of EUR 125,000) Open interest: 278,139
Commitments
137,061 64,627 5,763 82,406 153,006 225,230 223,396 52,909 54,743
Changes from 10/15/13 (Change in open interest: 20,940)
15,734 3,674 -279 -2,071 14,171 13,384 17,566 7,556 3,374
Percent of open interest for each category of traders
49.3 23.2 2.1 29.6 55.0 81.0 80.3 19.0 19.7
Number of traders in each category (Total traders: 196)
60 56 18 48 52 121 113

 

Note that that date falls on the high water mark at the 1.38 area!

EUR/USD spread betting chart

The importance of potential-momentum divergences

The most interesting data point from this report is the change from the previous week. It shows that both hedge funds and the small speculators ramped up their long positions by large margins.

The chart shows that this occurred during the last final spurt up from the 1.35 area, and just in time for them to suffer in the reversal!

Now, with most of the bulls already committed, there was no more buying power remaining. Consequently, the market on Friday fell, as many of the ‘last to the party’ bulls were stopped out – and the bears came out of hibernation.

On the above chart, one key indicator was the momentum reading, which was showing a potential negative divergence. This was cemented as the market declined.

You need to keep an eye out for potential momentum divergences when you suspect a trend is about to reverse. It is one of the most important factors I watch.

The Monday morning market

OK, so where are we today after Friday’s steep decline?

EUR/USD spread betting chart

I have drawn in a new tramline trio. The upper one has two to three good PPPs (prior pivot points), and takes in the single touch point of the 19 September high (recall this is wave A of the A-B-C rally).

My centre tramline is a good fit to the lows, and I have drawn in my third tramline, which gives me a possible target.

I have also drawn in my Fibonacci levels, and the decline has taken the market to the 50% level – a common support level.

And this is where the market is trading this morning.

Have the battle lines been drawn?

But that is not all – I also have to see if I can place any Elliott wave labels on the decline. After all, when I see a sharp move (in either direction), such as we saw on Friday, I suspect a third wave is behind it.

EUR/USD spread betting chart

This is the updated chart from Friday. If these labels are correct, then after the one-way wave 3 action, I expect a complex wave 4 up, where there should be much backing and filling over the next few hours.

Following the wave 4 high, I then expect a new move lower in wave 5 that should end at, or near, the lower tramline in the above chart.

This would set up a terrific battle, because it would occur in the area where the two major tramlines cross over:

EUR/USD spread betting chart

(I have taken out the upper tramlines for clarity.)

Of course, a significant break of this crossover area would send the market much lower.

Mapping the markets

But this morning, my best guess is that we should see a lot of two-way action over the next few days, followed by a significant bounce – perhaps even up to the upper tramline in a traditional kiss.

So you see how I use Fibonacci, Elliott waves and tramline analysis to draw a roadmap. And when the market follows it, it gives me confidence in my trade and in my targets.

But, as always, keeping to a sensible stop-loss policy is paramount, because sometimes the market ignores your roadmap and veers off in another direction.