A recent divergence between the Euro futures contract and the US dollar index is just one piece of evidence suggesting that the EURUSD has reversed course. Additional evidence includes a long term cycle, wave structure at multiple degrees of trend, and recent momentum considerations.
Market turns almost always occur with divergence. The most commonly recognized divergence is momentum (such as RSI) divergence whereas a new high is not confirmed by a new high in momentum and vice versa. A different kind of divergence occurs when similar markets fail to confirm new highs or lows. Equity technicians watch the Dow Industrial average and the Dow Transportation average at potential turning points. If one index fails to confirm the other’s new high or low, then the probability of a reversal is increased. This dynamic has occurred on 3 occasions since mid 2008*.
July 2008: Euro trades above prior high set in April 2008 but USD index fails to drop below April 2008 low - [B]USD bullish reversal[/B]
March 2009: USD index trades above prior high set in November 2008 but Euro fails to drop below November 2008 low - [B]USD bearish reversal[/B]
Now: USD index trades below prior low set in December 2008 but Euro fails to exceed its December 2008 high - [B]USD bullish reversal?[/B]
*there have been other instances of this divergence, but I am only showing the most recent instances in this report
[B]Euro / US Dollar[/B]
This is a chart that I have shown numerous times over the last year. It is important to keep in mind how important a USD turn may have occurred at 1.6000. Since the end of the Bretton Woods era, the EURUSD (DEM rates are used before 1998) exchange rate has exhibited a long term rhythm of roughly a decade up and six years down. If the rhythm holds, then the EURUSD is in a multi-year bear market.
[B]Euro / US Dollar[/B]
Wave structure is in agreement with the roughly 10 year up / 6 year down sequence. While not perfect (what real life wave count is perfect?), the decline from 1.6000 is characteristic of an impulse (wave 5 truncated). Given the amount of time that the consolidation since has consumed, there is little doubt that everything since October 2008 is a correction. Although some may have qualms with labeling the rally from 1.2454 as a truncated wave C, there is strong evidence that this is the correct interpretation. The rally from 1.2454 is a clear 5 wave affair (C waves are in 5 waves). Wave v of C is a diagonal with a textbook throwover (in which price exceeds the top diagonal line before reversing). RSI divergence is present at the recent high as well. A view of the weekly chart will show that last week’s price action traced out a key reversal. Sentiment figures, including COT data, warn of a turn. On a weekly closing basis, last week’s high is over 250 pips higher than the December high. On a daily closing basis, last week’s high is just several pips shy of the December high. This may be explained by the lack of liquidity that is common in December.
[B]Euro / US Dollar[/B]
Finally, the short term pattern confirms the bigger picture bearish view. The decline from 1.4452 is in 5 waves and 5 wave moves occur in the direction of the larger trend. One more low (below 1.4103) may be required in order to complete the decline from 1.4452 but a correction; back to at least 1.4223 and possibly 1.4300 will present an opportunity to sell the EURUSD with a stop above 1.4452.
Jamie Saettele publishes Daily Technicals every weekday morning (930 am EST), COT analysis (published Monday mornings), technical analysis of currency crosses throughout the week (EUR on Tuesday, JPY on Wednesday, GBP on Thursday, AUD on Friday), and the DFX Trend Index every day after the NY close. He is also the author of Sentiment in the Forex Market. Follow his intraday market commentary at DailyFX Forex Stream.
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