The benefits of patience when looking for an entry point

In my last post, I used the recent action in the EUR/USD as a terrific working example of how I use my trading methods – in particular, how I use a combination of Fibonacci retrace levels with my own tramline targets.

On the last chart, I projected the 1.4450 level would be a major target. At this level, the rally would carry to the Fibonacci 50% retrace of the big move down from 1.49 to the recent low at 1.39.

The euro nears my target

This morning (Wednesday), I saw that the high overnight has been just a few pips short of my target, and the market is currently toying with it as I write.

EUR/USD spread betting currency chart

(Click on the chart for a larger version

So is this a good place to short?

Recall that I mentioned previously that the euro and the Dow have been moving more or less in lock-step. Apparently, the herd believes that stocks should be bought whenever the dollar declines.

My interpretation of this is that the market believes that, through the quantitative easing (QE) dollar-printing process and the stated aim of the Fed to support equities, more (and cheaper) dollars mean higher equity prices. All of this in the face of a far from solid US economic recovery.

Add in the current wobbles in China and the sovereign debt crisis in the eurozone, and there seems precious little fundamental reason to buy stocks for the long pull.

That is the backdrop for the huge stock rally into early May – and highlights the dilemma facing stock investors.

Can the euro tell us when to short the Dow?

But back to the technical picture.

So let’s have a look at the Dow. Here is the latest hourly chart:

Dow spread betting chart

(Click on the chart for a larger version

There are several very important features I wish to point out.

First, I drew the first tramline across the tops from early May – this is the third-from-bottom line. Note the solid touch-points. This tramline is the equivalent of the similar one in the euro chart.

Also, note the break-through in the early hours of 31 May – and the pull-back right to the upper side of the line – and then a ‘scalded cat bounce’ up to its current levels.

This is classic market behaviour.

Second, I drew my lowest tramline right through the two solid lows of 5 and 25 May (marked with purple boxes). That is a very solid tramline.

Note that before the 25 May low was put in, we could have forecast that low just from those two tramlines!

Third, I drew my third tramline mid-way between these first two lines, and then I drew my fourth tramline equidistant above my third-from-bottom line.

I have drawn in my Fibonacci levels – and this morning, the market has hit my 50% retrace target.

Dow spread betting chart

(Click on the chart for a larger version

So to sum up, as of this morning, the Dow has hit an exact Fibonacci target, but is shy of my tramline target. And the euro has hit my tramline target, but is somewhat short of my Fibonacci retrace target.

At this point, a trader weighs all of this up, and acts (or not!).

For myself, I will just observe the action as it develops today and wait for a definite signal. At the back of my mind lurks the warning from the sudden turnaround in bullish sentiment towards the dollar in late May, which I mentioned in my last post. This could result in a deeper upward retrenchment in the euro – a short squeeze.

I decide to watch and wait – at least for a while.

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