I need one more signal to confirm a euro rally

I last covered the EUR/USD on 9 November and today I thought I would follow up on its progress, because it has hit one of my targets this morning.

Below is the daily chart I left you with last time. My centre tramline had been broken, and that set my target at the T3 support line. Naturally, the precise level of my target would depend on how fast or how slow the descent to it would be – and sadly, that was out of my hands! This problem is especially acute when dealing with highly sloping tramlines where the difference between a few days along T3 can be tens of pips.

euro / dollar spread betting chart

But here, I had moderately-sloping tramlines and I was reasonably confident I could set my target in the 1.06 – 1.07 zone. Today we’ll see how far the market is away from that target.

Hedge funds are shorting the euro – and they’re almost always wrong eventually

Since 9 November, there have been a few developments on the European Central Bank front with Mario Draghi announcing he “will do whatever it takes” (where have we heard that vow before?). This in an effort to raise the inflation rate (it is really properly called a ‘deflation rate’ now) from negative to something approaching the 2% target.

If Draghi’s programme is successful – and that is a very big ‘if’ – that would enable heavily indebted companies to inflate away their debt load in the traditional manner. An extended period of deflation, of course, would put huge pressure on them.

In any case, the last time Draghi uttered that vow, the market took the euro on a severe bear trend with heavy selling by hedge funds. Will lightning strike twice? Hedge funds evidently think so. In the latest week, hedgies (the non-commercials) increased their bearish bets and are now holding three times as many shorts and longs. The market is now heavily short – and could be ripe for a counter-trend rally to shake out the latest shorts in a squeeze. Here is the latest Commitments of Traders data:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
CONTRACTS OF €125,000 Open interest: 549,229
81,112 237,693 65,891 351,414 151,970 498,418 455,554 50,812 93,676
Changes from 10/11/15 (Change in open interest: 24,174)
-258 17,913 6,631 15,403 -863 21,777 23,681 2,397 493
Percent of open interest for each category of traders
14.8 43.3 12.0 64.0 27.7 90.7 82.9 9.3 17.1
Number of traders in each category (Total traders: 269)
60 122 70 58 64 158 215

So how far away is the market from my target now? Here is latest chart this morning:

euro / dollar spread betting chart

The low this morning is 1.0602, and has hit the lower edge of my target zone. Nice.

But can I make a case for a decent rally from here? I have a budding positive momentum divergence and if it holds, its strength indicates the snap-back rally could be vigorous.

On the hourly chart , I have a very good tramline trio in blue (this is not the same as that on the daily) and the market has broken T3 and is now pulling back to try for at least a kiss.

But what if the market catches a bid and pushes on past T3 and up towards my pink trendline? This line of resistance has multiple accurate touch points and I can use it as my line in the sand. If the market moves above it, the line switches to become support.

euro / dollar spread betting chart

Then, it would undoubtedly encounter masses of protective buy stops placed there by the bears – and light a fuse to rocket the market higher in a ‘surprise’ rally that would have the media in a tizzy trying to ‘explain’ it.

One slight problem with this scenario is that the 1.0460 March low has not yet been broken, which would make the wave labels look better. I cannot rule out this break just yet.

But I also have excellent tramlines on the wave down off the October high:

euro / dollar spread betting chart

That is a valid wave count – the market is currently searching for the wave 5 low. A break above my upper blue tramline would help confirm a decent rally is underway. But whether it is the start of a major relief rally of several hundreds of pips, we shall have to wait and see.