The euro’s bear market resumes

With the euro having crashed through its support levels, the rally has topped out and the bear market is back. John C Burford looks at how to play it.

Last Friday's article, Forget 13,000 this is the important level for the Dow, prompted lots of comments. There are certainly some strong views about where stocks are heading next, and I'll look at the Dow again soon.

I want to get back to the EUR/USD today, though. It's another market that's seeing a lot of action.

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And it's important, too because most markets are dominated by movements in the US dollar.

Euro crashes through last week's danger' level

On Wednesday, I noted the bear market rally off the January 1.26 low had taken it easily to my first target at 1.32, and had come within 100 pips or so of my second fantasy' target at 1.36.

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I showed you this chart which gave a level where I thought the rally would be in serious trouble:

12-03-05-MWT-01

(Click on the chart for a larger version)

And just look what happened. After writing that article, the market moved sharply down through that purple bar. The next chart shows the position at the time of writing this morning:

12-03-05-MWT-02

(Click on the chart for a larger version)

You can see how, on Wednesday afternoon, the market plunged rapidly through the lower tramline and below the minor support points.

Trader tip: This is a great example of why using stop orders can be a sensible entry method. Using a pre-determined entry level, as I did here, a resting sell stop order would have been triggered automatically. There was no need to be continually scanning my screen.

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And using a pre-determined entry level, there is plenty of time to work out a protective stop level in case the market suddenly reverses.

In case you missed it, take a look at the recent tutorial I sent on my 3% rule which explains how I work out my bet sizes and protective stop levels.

The upper tramline halts the bear market rally

OK, is this a high-probability trade? Let's go to the daily chart to get the big picture:

12-03-05-MWT-03

(Click on the chart for a larger version)

The first task I have is to look for possible tramlines. Right away, I have a great position for my lower tramline just admire the lovely touch-points as marked by the red arrows!

My next task is to look for an upper tramline. And I don't have to look far. It lies on the major highs including the latest rally high at 1.35. So my bear market rally carries right to this tramline. Nice.

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Remember, I could have drawn these tramlines in January when the market made its last low at 1.26. This is powerful information.

Also note the potential negative momentum divergence, where the 1.35 high was not matched by higher momentum. This gives added evidence of a rally top at 1.35.

Finally, there is a clear A-B-C pattern to the rally with momentum at the C wave lagging that at the A wave.

With all of this evidence, I have a very strong case that the rally has topped out and the bear market for the euro is intact.

Why caution is needed at this important level

Now, with the market off 200 pips or so from my trade entry, I can lower my protective stop to break-even, following my break-even rule.

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But I must not get too carried away here. As always, I must be vigilant for surprises, especially if trading in the short term.

Why am I cautious here? This morning, the market has fallen to the 38% Fibonacci retrace of the rally (see red arrow on second chart, which I'll repeat below) a typical level where support is found.

12-03-05-MWT-02

(Click on the chart for a larger version)

Also, there is a potential positive momentum divergence (marked by the green arrows) this is often a prelude to a reversal of some kind.

But as you can see from this next chart, so far the decline is following my new down-sloping tramlines, so all is well so far.

12-03-05-MWT-04

(Click on the chart for a larger version)

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If I were trading short-term, I would be tempted to take profits here, or set a buy-stop just above my upper tramline.

Both methods are acceptable. If taking profits here, I would have a known profit in the bank, but miss out on any further falls.

If using the second method and the market rallied through my stop, I would take a smaller profit. But I have the chance to benefit further if the market continues down.

Which method to choose in your own trading depends on your personality it's horses for courses!

Now, I promised you I would cover gold this week and that's still the plan. I hope to get to it on Wednesday and I'll have a very interesting chart to show you!

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:

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