The continued weakness in the European economy is reflected in the weekly euro-dollar chart. The euro-dollar exchange rate is an indication of what investors think about the health of the European economy. Expectations of change or decisive action to deal with growing debt problems result in short-lived rallies followed by a resumption of the long-term downtrend.
The dominant feature on the weekly euro-dollar chart is the downtrend line. The market has consistently reacted away from this downtrend line, using it as a powerful resistance feature.
The well established downward trend line A started in May 2011 from the high at $1.49. The price has moved up to the line and then retreated from the downtrend line on three occasions.
The current rally has a high probability of also reacting away from this trend line. This is a powerful resistance feature on the chart. On current values, the euro must move to $1.275 to break above the value of the downtrend line.
Downtrend line B is parallel to downtrend line A and creates a down sloping trading channel. Trend line B is used as a guide to the potential downside for euro retreats. A retreat from trend line A has a potential downside near $1.18 on the current value of trend line B.
The $1.24 support level defined the limits of euro weakness in 2008 and 2009 but it did not provide good support in 2012. The next technical down side historical support is near $1.16. The rebound rally from near $1.20 is part of the pattern of rally and retreat in the environment of a downtrend.
This rebound develops in mid-air and is not related to an historical support level. This suggests that the retreat from the downtrend line will carry the euro towards the historical support level at $1.16. Using the value of trend line B suggests the euro may reach the $1.16 target level towards the end of 2012.
The $1.16 level is a minor support level established in 2005 and the level has not been strongly tested. Support at this level may be temporary so traders will treat any consolidation in this area with caution.
If political solutions to the European debt crisis are unsatisfactory then the $1.16 support target will fail. A fall below $1.16 has a downside target at the next lower historical support level near $1.07.
The euro-dollar move below $1.07 is not unthinkable. In 2001 the Euro was trading at $0.88. There is low probability the euro will move above the value of trend line A so traders prepare to go short as the retreat develops from near trend line A.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
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