USD Index—daily ending diagonal

On the daily chart, one can interpret recent price action as an ending diagonal. I've marked it in red on the chart below. Prechter, in his book, Elliott Wave Principal, defines several rules for ending diagonals. In EW theory, rules cannot be broken.

The first rule is that an ending diagonal (ED) always subdivides into five waves. The second rule is that it must always occur in wave five of an impulse wave or wave C of a corrective zigzag or flat. Rule three states that each wave of the ED must divide into zigzags.

There are four rules concerning price action, i.e. wave two cannot exceed wave one, wave three always goes beyond wave one and wave four never exceeds wave two. In addition, this is the only time wave four can enter into wave one's price.

The pattern traced out on the daily chart meets all of these rules. including wave four penetrating wave one's price.

There are also several guidelines. For example, waves two and four usually retrace between 66 and 81% of the prior wave's price action. That doesn't happen here (in both cases it's less than 50%) but guidelines are just that—they don't have to be in place. Nonetheless, a reaction that can't reach more than 38% or so of the prior wave usually indicates a very strong trend down so an ED can fail. Nobody, unfortunately, has ever produced a valid study showing the validity of EW theory, let alone the performance of something such as the ED. The thing is, though, that if this ED does fail, i.e. price drops below the 75.24 low, that's a powerful signal.

If it is a successful ED pattern, then price action out of it is usually fast and powerful. This would be to the upside. There's other evidence for a violent move if price increases. There's significant sentiment against the USD. It's difficult to believe there are many people left to sell. The people jumping in now are typically weak players. Any rise in price would cause significant short covering. This would fuel an additional rise. This type of behavior leads to fast moves.

Note also the positive divergence on the daily chart. Whatever you think of the USD potential, this isn't the time to be going short.

There are other ways to interpret this chart than EW theory. As I wrote last week about the weekly chart, any move below the prior swing low of 74.16 confirms the downtrend with a lower low (and lower high). The failure of this ED from an Elliott perspective would hint at that possibility. Failed patterns are powerful signals. One can also see the possibility for a rectangle signaling range trading on this chart. I've marked it in blue. However, the next move would be up in that case to about 81.10. Coincident or not, that target is near the price projection of 81.35 from the ED (the origin of the pattern).

Here's the daily chart:

© Dianne Fecteau, 2011. 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.