Big counter-trend rallies in the euro – as forecast

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If I were a video cartoonist, I would love to create a video where the eurozone bigwigs are huddled around a mike singing Breaking Up is Hard To Do. It would go viral on YouTube, I’m sure.

But hold on – has the long-heralded break-up been delayed yet again? To the backing sound of cans being punted along the tarmac, it appears so. When will we run out of road?  That is the Big Question.

As I mentioned on Wednesday, the chorus of negative news and comment reflected a massive low in bullish sentiment towards the battered euro.

And since markets very often make turns at sentiment extremes, I was able to pinpoint an entry for taking a long position at the 1.2375 area last Friday, having (slightly prematurely) taken a large profit on my latest short trade earlier.

So, I was long in a bear market. For some that is scary. But I know from experience not to hang around too long and be greedy, and to take a decent profit when offered.

The perfect pattern for a swing trader

And that is exactly what occurred yesterday. Here is the screenshot of the chart at mid-afternoon as the market had made it to the exact Fibonacci 62% retrace:

(Click on the chart for a larger version)

I had a super entry close to the low and a textbook exit on a Fibonacci retrace – and note the A-B-C format to this rally, telling me that this is only a rally in a bear market.

This is about as good as it gets for a swing trader – and I took about 240 pips from this long trade.

Not only that, but I also reversed my position to get back short, where I am most comfortable (trading with the main trend).

Why I am a swing trader

The other benefit to my swing trading approach is this: If I were a position trader and had remained short through the rally, I would be seeing 240 pips of profit slip away. That would do my well-being not a lot of good!

Of course, it was impossible for me to say at last Friday’s low how far any rally would carry and if we would actually see an A-B-C form. Also, I could not be 100% certain that we would see a rally at all, of course.

And if the rally were more substantial, I would see much of my large gain erode away – and perhaps get me into a losing situation. Imagine how I would feel. I would be kicking myself.

My frame of mind would then compromise my trading, and the odds would increase that I would make unsound decisions. I want to avoid that at all costs.

To get back to my long trade – as I explained, the odds were stacked up in my favour – and that is all we can possibly expect to work with. Trading the markets is a probabilistic endeavour.

So that is why I decided to take the long trade and see what developed.

Trader tip: Long-term position trading can work, but you need a lot of luck and intestinal fortitude to sit through often gut-wrenching reversals. Personally, I am too much of a coward to do this. Swing trading suits me much better. I believe it is the style that most spread betters prefer anyway.

This euro rally has gone hand-in-hand with the massive Dow rally – I will cover the Dow next week – and this rally has been marked by an obvious short squeeze. This is the situation I anticipated, since we have the right conditions – namely, a severe crowding to the bear side. It was a ‘crowded trade’.

Let’s take a look at this morning’s chart:

(Click on the chart for a larger version)

The A-B-C form is clear, and so are my tramlines. There is the spike low of last Friday and the ‘pigtail’.

This is textbook Elliott wave and tramline behaviour for a bear market rally.

So now I have a short position and have moved my protective stop to break-even – I have a free ride.

Now the market has moved down to my lower tramline – will it break it or bounce up?

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Always look at the bigger picture

This brings up an important factor. Normally, the rule for trading along the tramlines is to cover shorts and go long, expecting the tramline to continue to act as support.

But, as always, we must consider the context within the bigger picture.

First, we are in a strong bear market. Second, we have just completed a classic A-B-C (corrective) rally. So the odds favour a resumption of the bear market.

If we were in a bull market, covering here and going long would make sense, but we are not.

That is why my policy is to hold my short trade, and expect a break of the lower tramline at some stage – maybe not here, but perhaps later. If I am wrong and the market does rally here, I may get stopped out at break-even. That is the ‘worse case’ scenario. But then I would still live to fight another day with capital intact – and that is my goal on every trade.

Market update: The market has just broken beneath the lower tramline as I write.

Trader tip: Many traders make the mistake of trying to guess the market direction using logic. They want to brag about their inspired forecast (or keep quiet about it, if wrong). These traders are more akin to gamblers than true speculators.

If you tend in this direction, try to wean yourself away from your opinions and just use the charts to guide your forecasts. Keep an open mind!

The bond market

Before I go, I want to leave you with some food for thought and mention that US Treasury bonds continue to flash warning signs that a big deflationary wave is approaching.

With the ten-year yield having made an all-time low, I believe a reversal is at hand. Here is a chart going back to 1960 (courtesy of elliottwave.com) showing the over 90% plunge in yield since the 16% top in the early 1980s.

(Click on the chart for a larger version)

Treasuries have been havens of sanctuary in the face of declining asset markets, as we all know. But not for much longer, I believe. Remember, gold had acted as such a haven for years, but topped last summer, and is losing its lustre. I feel Treasuries will suffer the same fate, as it too is a crowded trade.

I will leave you to ponder the consequences of rising interest rates – and in my opinion, it will not indicate a return to inflation ahead.

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

• The essentials of tramline trading
• Advanced tramline trading
• An introduction to Elliott wave theory
• Advanced trading with Elliott waves
• Trading with Fibonacci levels
• Trading with 'momentum'
• Putting it all together

• Don't miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here .

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Published in Spread betting blog More articles by John C Burford