The technicals say…

Posted by Scriptaty | 5:49 AM

The U.S. dollar was severely oversold by the end of 2004. It shows a weekly chart of the euro/U.S. dollar rate (EUR/USD). At its highest point on Dec. 31, 2004, the pair was very far away from its 20-week (100-day) moving average (blue line), something that put traders on alert for a possible bearish reversal.

Unfortunately, markets can remain overbought or oversold for many days, weeks, or even months. The trigger in this case was a bearish signal on the weekly candlestick chart, specifically a “hung man” (a bear ish reversal in candles) at the highest point on the chart. Once it formed, EUR/USD started declining. There was an attempt to nip this downtrend in the bud, but the rally in early spring 2005 came up short; once support at 1.2750 gave way, EUR/USD began to slide in earnest. (Also notice that once the pair penetrated the support of the 20-week moving average, this line turned into significant resistance for several months).

As a technician, one had to wonder what was next in store for the market. It is another weekly chart. The EUR/USD pair was making an effort to form a long-term head-and shoulders formation. The successful penetration of the neckline at 1.1885 on a closing basis would signal the start of another significant decline, and the target of its bearish reversal formation would be the distant 1.0055 area.

A closer look gives a better idea about the path the euro/dollar followed. The pair completed a double-top formation in early 2005. Most of the third quarter of 2005 consisted of a recovery from the sell-off, but despite the natural disasters endured by the U.S., EUR/USD only managed to test the neckline resistance before resuming its downtrend. At this juncture, the euro/dollar rate remained in a longterm uptrend but was going through a medium-term downtrend. It shows a set of Fibonacci fan lines drawn from the September 2003 low. The first fan line gave way quickly in spring 2005, but the 50-percent line proved to be a price magnet for 11 weeks.

Although the short-term outlook was negative for the euro/dollar, only a close below the pivotal low of 1.1866 would confirm the acceleration of the downtrend and a test of the 61.8-percent fan. This would also result in a downside breakout of a bear flag formation, and would add confidence in a negative outlook.

Dealing with the market is a type of hustle. Holding on to a short position when news sounds positive is no picnic.

However, in this case, the application of Fibonacci arcs proved very successful. It shows how EUR/USD was trapped between the 38.2-percent and 50-percent arcs on a daily basis.

In this case, the struggle between the bullish long-term outlook and the bearish medium-term and short-term outlooks was reflected in another set of Fibonacci arcs based on the major EUR/USD uptrend. It shows price tested the long-term 38.2-percent arc, but held. Once again, only a close below the pivotal low of 1.1866 would confirm the acceleration of the downtrend.