Focus on the Euro: January 6, 2012


Equities still locked in a tug-o-war, so I’m focused on the EUR this morning  — it completed the latest Butterfly pattern we’ve been watching.   Charting with Harmonics and channels has been incredibly accurate for the past week.  Here’s the short term forecast I posted Monday.

 And, the actual results (I changed the forecast line to red for better visibility.)

So, let’s step back a bit and look at the bigger technical picture.  The following weekly chart shows the history of the Euro – USD relationship.   Euro coins and bills entered circulation in 2002, which just so happens to be a great fan line origination point.  It was trading at the time at around 83 cents.

Over the next six years, EURUSD soared to over 1.60, where it began a huge flag pattern that continues to this day.  Within the flag pattern, distinctive channels have developed.  The impulse moves down have largely been confined to the purple parallel lines, and the corrective moves up have followed the white, dashed lines.

Looking at the current channel down, we can see that it’s been frequently “interrupted” by diagonal corrective waves that follow the exact same slope as the much larger corrective channels.  I’ve called these “diagonals” for purposes of brevity.

It’s happening on a both a large scale and small.  Note that the thin, red diagonals are the same slope as the large, white dashed channels.  If you look closely, you can see what look like little continuation head and shoulder patterns playing out, with the diagonals acting as necklines.  They’ve taken on the appearance of stair steps ever since Oct 27.

Another notable feature of this market is the accuracy of harmonic patterns in predicting future price moves.  The yellow Crab pattern in the middle of the above chart is a great example.  Crabs look like a big “W” and follow a X-A-B-C-D pattern like most harmonics.  Once the X-A leg is established, we look for a reversal (retracement) to a Fibonacci level (indicated by the purple grid in the background.) Here’s a close up.

In this case, the reversal (Point B) came right around the .618 level, which left open the possibility that we’d eventually see either: (1) a Gartley that would extend to the .786 level; (2) a Bat that would extend to the .886 level; or (3) a Crab that typically extends to the 1.618 level.   In this case, that’s 1.2464 — a good 12.5% off the most recent (Oct 27) high.

When harmonic patterns reach their target, we look for a reversal.   Sometimes it’s small, sometimes massive.   In this case, we saw small reversals .01 – .02 back to a previous Fibonacci level (.618), followed by a continuation of the down trend.   Along the C-D leg, however, we’ve seen multiple harmonic patterns unfold, each adding another step to our staircase.

The latest to play out was a Crab or Butterfly that indicated a downside to the 1.618 extension at 1.2723.  We reached that and then some this morning, tagging 1.2696 and an important fan line in the process.

Although we’re still likely heading for the larger Crab target of 1.2464, we should expect a reversal back to a previous Fibonacci level or even back test the diagonal at this point.  A subsequent break of the diagonal — perhaps after forming a little H&S; pattern — should help us on our way to completing the larger pattern at 1.2464.

Note that at that point, we also tag a fan line from 2002.  Remember this chart from above:

Those dashed red lines from 2002 intersect with the lows of our flag pattern and influence what happens going forward.  In previous cases, they provided a bounce of a few cents.  When they were broken afterwards, EURUSD saw a particularly strong downdraft.

So, a bounce at 1.2464 makes perfect sense, as we’ll have completed the large Crab pattern and tagged one of these fan lines.    But, remember, we won’t complete the flag pattern until we reach somewhere around 1.135 — another 10.7% below current prices.  It could happen in a hurry when downgrades are announced for EZ sovereigns and/or the ECB.  

And, of course, there’s no guarantee that we’ll bounce at the bottom of the pattern.  In a vacuum, one would be tempted to see the past six years as the head in a giant H&S; pattern.  But, of course, we’re talking about the Euro in relation to the USD.  And, it’s simply a matter of time before investors notice the smoke coming from that tent as well.

Good luck to all.


Focus on the Euro: January 6, 2012 — 3 Comments

  1. What do you think of the disconnect between the drop in EURO versus the "unchanged" SnP? They used to move lock step. There is no fear in the market, the VIX is dropping to 20, the rise in USD has no effect on equities so far…What's holding equities up?? One has to wonder. Love to hear your input. Do you have some insight about Gold?