Record low interest rates – how did the euro react?

The euro's reaction to the interest rate decision punished many erring traders - on both sides of the market, says John C Burford. Here, he surveys the fallout, and plots his next trade.

On Wednesday, the market was in a strong rally mode and I was working a long trade.

And yesterday, the long-awaited announcement from the European Central Bank(ECB) revealed thatit was loweringits policy rate from 0.75% to 0.5%.

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Just how this is going to lower the eurozone unemployment rate from a record high (and growing) rate of 12% and stimulate GDP growth rate above zero (and falling) is beyond me.

I have written recently about the misconception that it is policy decisions that drive markets. For example, the ECB's recent decision to lower rates. It is actually the negative sentiment in the eurozone which is producing the weak numbers, which is forcing the ECB to lower rates.

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Why I decided to lighten my position

On Wednesday, the market was approaching the 1.32 level on the strong rally.

This is what I wrote: "Now, the next target is the previous major high at 1.32 set on 16 April. I imagine that there are plenty of buy stops sitting right there."

And sure enough, the market squeezed those shorts a little more tightly and took out the 1.32 level:

13-5-3-MWT-1

(Click on the chart for a larger version)

Now, with that important 16 April high taken out, the question all traders need to ask is this: Is there enough gas in the tank to sustain the rally?

Many experienced traders have a policy of always fading these situations, especially after a sharp move, such as we have seen here. Fading' simply means selling short into the move above the old high at 1.32.

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Now, you run the risk of being on the wrong side of a massive trending market, of course. But that is what stops were invented for.

On balance, I have found that more often than not, the markets pull back from their rally after the surge of buy stops has been exhausted.

I decided to lighten up on my position, since Wednesday was the eve of the ECB announcement, and I expected increased volatility. I had a decent profit and I was not about to get greedy.

I offset part of myposition around the 1.32 level and placed a protect-profit stop on the remainder around the 1.3140 level.

And this is how the ECB news was taken:

13-5-3-MWT-2

(Click on the chart for a larger version)

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First, the market rallied above 1.32 (red arrow) in gladness that the new rate was not below zero, but then had a swift change of heart and sank 150 pips in an hour or so (blue arrow) as traders punished those who took long positions above 1.32 by running their sell-stops.

It's a cruel world in the space of a few hours, both longs and the shorts were punished, and the market has ended up in exactly the same spot it was on Tuesday!

Let's take a look at the bigger picture

13-5-3-MWT-3

(Click on the chart for a larger version)

Wednesday's rally high took it to the exact Fibonacci 50% retrace, so that was another reason for me to take profits.

Also, the rally from early April has a nice A-B-C form to it (green bars), suggesting this is a counter-trend move and the one larger down trend remains intact.

To cap it off, there is a stark negative-momentum divergence at Wednesday's C wave high.

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This is as close to textbook as you'll find.

Nailing that closing price

So can I find a suitable entry this morning? Let's zoom in on the 15-minute chart:

13-5-3-MWT-4

(Click on the chart for a larger version)

Using yesterday's high and low as pivot points, I can place my Fibonacci tool.

And as I write, the rally has carried to the 38% level and appears to be stalling. This rally has an A-B-C feel to it, so the relief rally could be complete here.

But later today, there is yet another important economic report: the US employment situation, which will also be closely watched. This could induce added volatility again to the dollar.

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Ideally though, the rally would carry to the 50% level above 1.3120, where a trade could be entered. Based on my analysis the 62% level is also a potential turning point.

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

Don't miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here . If you have any queries regarding MoneyWeek Trader, please contact us here.

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