By Jim Hyerczyk
Commodity Trading Advisor
I believe that in order to analyze a financial market properly, one has to look at the charts using a top-down approach. This means starting with the monthly chart and working down into the weekly and daily charts.
Using this approach probably would have kept you from getting too excited about last week’s rally in the EUR USD as you would have clearly seen that the Euro was still in a downtrend and that the downtrending Gann angle at 1.2860 on the monthly chart was still providing solid resistance. While this resistance is easily identifiable, for that matter, so does the next likely downside target t 1.1876.
The Euro rallied early Sunday after initial Greek election results seemed to indicate a win by the pro-bailout, pro-Euro party. The euphoria died quickly however as the air was let out of the rally balloon as traders quickly turned their focus on Spain and Italy.
A drop in Spanish and Italian stock markets coupled with the sharp rise in Spanish government bonds encouraged traders to fade the rally in the Euro, demonstrating that they had already moved past the Greek elections. As Spanish government bond yields reached Euro-era highs above 7 percent, traders expressed their concerns about Spain’s fiscal and banking system problems. Traders are once again looking toward the European Central Bank for aid to stop the steep rise in bond yields.
The 7 percent level is critical as many feel the country cannot operate with yields this high, putting it in a position to receive a bailout. In the recent past, Greece, Ireland and Portugal sought international bailouts after their 10-year bond yields went beyond the 7 percent level.
The weekly chart was showing a similar downtrend. Not only is the Euro producing a series of lower tops and lower bottoms which is the classic definition of a downtrend according to the swing chart, but the market was also following a pair of downtrending Gann angles at 1.2580 and 1.2887. The trading action early Sunday helped the Euro cross to the bullish side of the downtrending Gann angle from the 1.4940 May top, but it also allowed it to enter a downtrending channel down formation. Until this chart pattern is violated or the Euro crosses a main top, the downtrend should remain firmly intact.
Looking at the daily chart, EUR USD surged through a major downtrending Gann angle at 1.2603. This helped propel the single currency through a steep uptrending Gann angle at 1.2727. After failing to reach a critical 50% level at 1.2785, momentum shifted as short-traders reapplied pressure.
Despite the eleven day rally from the 1.2287 bottom, the main trend in the Euro never turned up. This is clear evidence that the recent rally was driven by short-covering. Some speculative buying may have been involved in the rally, but for the most part, the move was created by weak traders covering their shorts in an over-reaction to the possibility that central banks would intervene to boost the Euro.
With sentiment shifting back to the downside, traders should watch for a 50 to 61.8 percent correction of the rally from 1.2287 to 1.2747. This potential target zone is 1.2517 to 1.2463. Additionally, uptrending Gann angle support comes in at 1.2507. This creates a potential downside target and support cluster at 1.2517 to 1.2507.
With Euro investors shrugging off the good news from Greece, traders should watch for downside momentum to build throughout the day with the possibility of a massive closing price reversal top. In addition, look for volume to rise as the market falls, setting up the possibility of a volatile outside move day.
Before getting caught up in the news driven short-term charts, it is important to look at the longer-term chart then work down into the short-term charts. Keeping the focus on the main trend of the longer-term charts will help prevent being caught in a bull trap like the one formed by the Euro on Monday.