Wednesday, September 29, 2010

EURUSD—rally getting to risky levels

The Euro has made another new high of 1.3638. However one can make an argument that this rally is getting old and the risk for new longs is becoming higher.

Yesterday, I pointed out that drawing a line in parallel with the uptrend line on the weekly chart implies a high of 1.3726 before correcting downwards. I've drawn it on the daily chart below as well. This is an Elliott Wave (EW) approach to estimating where an ABC correction ends. (Frost and Prechter, 2005).

First, you draw a line connecting the beginning of wave A (1.1892) to the end of wave B (1.2588). Then you draw a parallel line that starts at the end of wave A (1.3335). As Frost and Prechter (2005) write, "Wave C often ends upon reaching" this parallel line (p.89). The end point is now around 1.3750.

Another interesting thing about the daily chart is that there appears to be an ending diagonal that ends about that same point. When a corrective wave contains an ending diagonal it's always in wave C or a zigzag or flat.

Finally, note on the daily chart that Euro is overbought (over 70 on the RSI indicator). This is normal in third waves and a C wave is a third wave.

Can I validate the price target of 1.3750 in another way besides using EW theory? Yes. 1.3750 is polarity (i.e. the March, 2009 high and the June, 2009 low) although there's really a polarity zone that extends up to 1.3850. There's other evidence prices could extend to the 1.3850 area. This is approximately 50% of the move from the 2002 low to the 2008 high and it's also polarity as I just mentioned.

Dropping down to shorter time frames (1- and 3-hour) suggest this rally is getting tired with their negative divergences.

All this suggests potential shorts being the way to go. The entry point is what's important here and of course a tight stop. In the face of a rally you have to be careful. Using EW theory, it's not unusual for wave C to be the same length as A. This would imply a top of 1.4030. Short covering if the pair got above 1.3850 would fuel this kind of rise.

The other issue is that Euro broke above good resistance in the 1.35 area. If price pulls back to this area then you'd want to take some profits if short. Others might try a long here although waiting to 1.3335 would be better. The point is that this will be an area where, regardless of future direction, you'll see some stalling.

I have one other concern about the Euro and this is that it broke above the top speed line (the faint pink line on the chart). However, while this is significant it's only one small piece of evidence that this could be part of a much bigger move up and little else validates it as of yet.

Bottom line for me is that I will probably try a short around 1.3720.

Here's the daily chart:

© Dianne Fecteau, 2010. No part of this material may be reproduced in any form, or referred to in any other publication, without the express written permission of the author.

My purpose in writing this blog is to show you how one trader, me, makes trading decisions and survives while trading Forex. One of the biggest problems I had when I first started trading was trying to apply the “rules” to actual trades. Another was the psychology—limiting losses and letting profits run. If you study my blog, you’ll see how I deal with both those issues. So my writings are not trade recommendations but rather educational in purpose. You have to decide on your own approach to trading. Remember that trading is risky.

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