The euro rallies – but where to now?

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Since early this month I have forecast a sharp rally in the EUR/USD. My view was formed by the technical picture and you can read my analysis in previous posts: The most important chart of the year so far, and most recently, Is the euro now in a bull market?

But now the rally is underway, more and more pundits are jumping on the bandwagon. Hindsight is a wonderful thing, but no-one makes money trading it!

Recall from my post on 4 January, The ultimate contrarian trade to kick off 2012, the euro had precious few friends. To most traders, going long the euro then was considered suicidal.

If I were trading on the ‘fundamentals’, I would be scratching my head trying to understand what has happened since!

But now the EUR/USD is rallying, going long does not seem so crazy for technical traders, like myself. Naturally, when the majority believe in the euro again – as they will – that will be the time to reverse.

How to spot a low-risk entry

One of the keys to successful swing trading is to be able to identify a low-risk entry. That means getting in very close to the low (or high if you’re going short). That way, close protective stops can be set, limiting risk.

At these points, it seems you are trading against the trend, which is usually discouraged. But by following my methods, where I use tramlines, Elliott waves, and Fibonacci, I am able to identify some of these low-risk entries.

Of course, there are other excellent methods out there that can accomplish this, and I would encourage any trader to investigate them.

Every successful trader I know has found and developed a method that works for them. No two traders use a system in exactly the same way. You must find and adapt a method that suits you – and sometimes, that can mean going down a few blind alleys first.

OK, now let’s have some fun.

The euro could be setting up for a major rally

Take a look at this daily chart of the EUR/USD:

(Click on the chart for a larger version)

Is it possible that the market can extend its current rally more substantially?

We have seen a 400-pip rally so far. The blue box on the left contains the October 1,000-pip rally off the positive momentum divergence (green arrows).

But look at the right-hand blue box – here we also have a rally coming off a positive momentum divergence.

Can history repeat? If so, then if we get a similar-sized rally this time, my target would be in the 1.36 – 1.37 zone. Talk about a home run!

OK, now take a look at this daily chart:

 

(Click on the chart for a larger version)

I have drawn in my tramline pair which contains several excellent touch-points. If the market can make it to my upper tramline, that target would be in the same 1.36 area.

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Hmmm. This is getting interesting.

So where are we this morning? You can see on this expanded daily chart:

 

(Click on the chart for a larger version)

I can see that the rally has carried right to the Fibonacci 23% retrace. It’s now trading in the chart resistance zone marked by the thick red bar. This zone is where there was congestion on the way down in late December.

I would expect at least some pause here, and possibly a top, if the market so decides.

Check out this text book Elliott wave pattern

But now take a look at the hourly chart, which shows the form of the rally:

(Click on the chart for a larger version)

This is a magnificent example of a textbook Elliott wave structure.

First, I can count five clear waves – three up and two down – with the final fifth wave still to be made. The third wave was “long and strong” with high momentum – a textbook case.

Second, all waves are contained within my tramlines with excellent touch-points.

They really don’t come any better than this.

Also, can you count a clear five waves within wave 3? That is yet another perfect third wave structure.

OK, we know what should happen after the fifth wave is put in – a three-wave decline. So that is what I expect in the next few hours.

Look out for the Fed announcement later today

But of course, this upward five-wave pattern is telling me that the major trend has turned up (for now). That would set the cat amongst the pigeons, as the majority are still bearish and are shorting into this rally.

Interestingly, we have a much-anticipated Fed announcement later today (5.30pm UK time) and this news could induce the moves I am expecting.

One of the key markets I keep my eye on is the US Treasuries – and the T-Bonds have taken a tumble recently, reflecting the recent move out of risk-off positions. Sadly, there is no rolling T-Bond market, so I watch the future – the March contract is available to trade currently.

If T-Bond yields continue to rise, then the implications for the US economy are very negative, and would likely spike the nascent recovery that has got the stock market excited.

The Fed has been the major buyer of the T-Bonds recently, so any change in policy would have a severe impact. That could really move the EUR/USD.

But if my ‘fantasy’ target of the 1.36 area is to gain traction, I need to see a move up to my first long-standing target of 1.32 for my first home run.

But I am now on second base – and that was inconceivable in December.

• 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