Weird stuff in the currency markets this morning.  EURUSD busted its previous high, so out with the old and in with the new harmonic pattern.  In so doing, it reached a .886 of its now previous high, but after a .707 Point B — which doesn’t make for a solid Bat Pattern.

Furthermore, the smaller white pattern (the lower case letters) hint at a 1.618 extension rather than the existing 1.272 — though that would leave the larger pattern in no-man’s land shy of its 1.272 — with no .786 to support it.

As I often have to remind myself, there are forces at work in the universe other than harmonics.  Not every move has to fit a harmonic pattern.  There’s a perfectly good purple channel up here that, depending on where you draw it, could/should easily swat the EURUSD back down in a big way.

Bottom line, be aware that this pattern break could be positive for SPX — which reached an important bunch of Fib levels yesterday and was presumed to be selling off in search of a Point C down around 1444.

We had positive housing news that has the futures up a bit (+2 as of 9:25) going into the open.  So, keep your stops where you’re comfortable and we’ll try to sort this all out.

UPDATE:  9:45 AM

SPX just tagged the 1.618 (it was .26 short yesterday.)  But, it appears to be on course for the .786 at 1461.24.  Look for a turn there — also the scene of the expanded red channel top — or at the yellow .786 of 1464.03.

It would help the downturn case immensely if DX could complete a proper Bat Pattern down to the 78.906 level.   We’ll look at the implications of all this in a few minutes.

UPDATE:  10:25 AM

So, a .786 Point B is different from a .618 in the land of harmonics.  If prices are to move higher, it portends a Butterfly Pattern that can extend to the 1.272 (1483) or 1.618 (1499.)

I say “if” because quite often the .786 is the end of a counter or corrective wave in the midst of a primary move in the other direction.  But, such instances typically (not always) show more signs of a big reversal — such as a more pronounced Point B at the .618 on the way up to the .786 (indicating a completing Gartley Pattern) and/or corroborating charts among other indices and currencies.  As discussed above, we don’t have those here.

In the absence of other evidence, the only way you know for sure whether a .786 (or any other Fib level) marks the end of a counterwave (and resumption of the primary) or is merely a pause before prices head higher is whether the market reacts in a meaningful way or not.

That’s why a lot of harmonic investors are scalpers — placing a bet shortly before reaching potentially important Fib levels and blowing out the position quickly if they don’t get the reaction they were expecting.

Getting back to the above chart… Note that the Point B at the white .786 is at 1461.24, while the yellow .786 is up at 1464.03.  Remember, the Point A down at 1425.53 serves both patterns.  The only difference is where they started (Point X.)  Because the white pattern is contained within the yellow pattern, the yellow pattern should trump in cases where they conflict.

Yesterday, it didn’t much matter — as they were within a couple points of one another and there were several other Fib levels close by.  But, the implications become bigger as the pattern extends.  The yellow 1.272 and 1.618, thus, are at 1488 and 1505.

Anyway…we have the EURUSD at a .886 retracement of its former high (Sep 17 – 1.3171) but a dollar that hasn’t quite reach its (78.906 would be a .886 retrace of its Sep 14 78.725 low.)

The euro threatens to break out of a channel that dates back to November 2010.  If it doesn’t reverse very quickly, the next stop is 2% higher at 1.34 (the 1.618 of the 1.3171 to 1.2802 drop and the .618 of the 1.4246 to 1.2041 drop.)  Note: there is significant negative divergence in every time frame from 15-min up to daily, so a big reversal here should be no surprise to anyone.

An equivalent move lower in the dollar would mean 77.209 — a .618 retracement of the entire 72.86 to 84.245 move from May 2011 to July 2012.  This would fit pretty well with our  DX forecast from October 3.  But, again, there is significant positive divergence across the board in the dollar.

Needless to say, such a 2% move in both could easily produce a 2% move higher on SPX.  Figure 30+ points — which would be in the vicinity of the 1.618 extensions mentioned above (1499-1504.)  The 1.1% decline in DX from Sep 28 to Oct 5 accompanied a 2.4% ramp in SPX.

For the sake of argument, suppose a 1% DX move produced a 2% SPX move.  Then, a DX decline to that .618 at 77.209 would align with a 67-point SPX move to 1527 — just beyond the 1.618 extension (at 1518) of the SPX plunge from 1422 to 1266 over the summer.

SO….

In my opinion, the EURUSD freight train has to turn, and turn quickly, if 1474 is going to hold.  I’m going to take a few minutes to examine this more closely.  I’ll be back asap.

In the meantime, those of us who were stopped out this morning might want to re-short either here or the somewhat more likely reversal of 1464.03.  If you’re holding short, be prepared for the possibility of 1469 (the yellow .886.)

More shortly…

UPDATE:  12:55 PM

My apologies for the delay.  Sometimes, as I’m working out a forecast, a harmonic pattern pops up and insists on being considered.  Here’s what I’m noticing…

It’s really puzzled me that the harmonic patterns, which have dove-tailed so beautifully for the past three years, would suddenly not. Specifically, the extensions of the yellow pattern (from 1474 on Sep 14 to 1425 on Oct 12) don’t line up with any of the previous patterns’ Fib lines.

The 1.272 is up at 1487 and the 1.618 is at 1505.  About the only thing giving them any scent of legitimacy is the relative closeness to 1500 — a nifty top from a history book perspective.

Consider the red Butterfly pattern by comparison, which made a nice turn at the 2007-2009’s .618 at 1228, put in a Point B at the .786 (thus signalling a Butterfly) and then produced a great reversal within inches of the 1.272.

It’s 1.618 is up at 1515 — only 3 points  from the 1.618 of the purple Crab Pattern from 1422 to 1266.  The purple pattern’s 1.272 was only 9 points away from the 2007-2009’s Bat Completion at 1472.

That’s how harmonics normally work.  Things align, with the completion of one pattern setting up or fulfilling the next.  So, again, what’s with the yellow pattern?

Regular readers know that I was surprised at the market’s relatively tame reaction upon reaching the .886 retracement of the 1576 to 666 crash.  Suppose there’s more downside to come?  And, suppose it comes before the move up past 1500 discussed above — or even negates a move higher?

I’m going out on a limb here, but I found that by moving Point A of the yellow pattern lower we can get it to line up quite nicely.  Spooky nicely.

Below you will find a close-up of the above chart.  Note the yellow grid in question — which, ideally, should provide guidance regarding the next leg up.

I’ve added another grid (in red): a measure of the move between 1396.56 and 1474.51.  This illustrates the degree of any retracement from the 1474 high.  SPX slightly exceeded the .618 of 1426.39 back on Oct 12 — which flustered some Elliott Wave folks by overlapping the Aug 21 high by 1.15.  Without digressing into a EW discussion, let’s just all agree that it complicated things (at least).

If 1474 was a normal wave 3 or wave 5 high, we would typically be open to a corrective wave of greater than a .618 retracement.  Look what happens if we make it a .786 or .886 retracement.  Suddenly, the yellow 1.618 lines up very nicely with the other 1.618’s up there at 1515-1518.

If we force a .886 retracement, it lines up even better — landing right in the middle of the others.

Of course, a dip to 1405 flies in the face of my expectation that TPTB would engineer a feel-good rally into the election.  A 3.8% correction now, with only three weeks to spare, certainly wouldn’t help preserve the status quo.  But, as we’ve seen in the news this past week, maybe Wall Street is ready for a change.  What an interesting battle that would be:  Bernanke versus Dimon, Blankfein, et al.

If we reverse hard at these levels (1462-1466), I’ll consider the above scenario very much on the table.  There are enough bearish warning signs to support it: the 60-min and daily RSI channels…

DX is close enough to a significant reversal point, very deep into a falling wedge with RSI breaking out from a long down-turn — much like at the October 5 SPX high of 1470.  It’ll probably tag the .886 at 78.906 after-hours.

The EURUSD is quite deep into a rising wedge at the intersection of two harmonic resistance levels on negative divergence and with and RSI channel pointing down.

I don’t know if there’s anything to it yet, but the Financial Times reported today a key aspect of the Save the Euro Zone campaign may be in danger.  Zero Hedge’s take can be found here for those who don’t subscribe to FT (but, it’s free, so why not?):

A plan to create a single eurozone banking supervisor is illegal, according to a secret legal opinion for EU finance ministers that deals a further blow to a reform deemed vital to solving the bloc’s debt crisis.

For those who have been waiting patiently (and the rest of you) for a short, sweet buy/sell signal with limits and stops, I hate to disappoint you.  We’ve been right on the money for over a month, now — with great returns to show for it.

I normally suss these things out sometime between putting the girls to bed and nodding off at my desk around 2am.  But, this seems important enough to devote market time to it.  This outcome, if it plays out, represents a big shift in my thinking.  And, I don’t take such things lightly.

I’m very comfortable going into the close short, with the understanding that we could still run up and tag 1464 or even 1466 before reversing.  We’re up enough this month already that I’d allow loose stops.  The behavior of the currencies after-hours will tell us a lot.

More after the close.