The short-term gyrations of Portuguese tinkering, Irish blarney, Italian bluster, Greek debt and the care-free Spanish (PIIGS) have a cumulative impact of the euro-dollar relationship.
The weekly euro-dollar chart gives a better view of the strategic perspective. Against this chart we must also balance the degree to which the greenback's strength, as shown on the U.S. dollar index, is increasing the pressure on the euro as distinct from pressure applied by the Euro zone PIIGS.
A simple analysis of the Euro-Dollar chart has these features.
This analysis is simple and effective. The conclusion is that the downtrend is likely to continue and set a downside target near $1.25. This historical support level has a high probability of providing a rebound area and a breakout form the downtrend line. Obviously the weakness in the Euro is driven by the internal politics of the Euro zone.
And that’s where most euro-dollar analysis starts and ends. Currencies do not exist in a vacuum. They have close, almost incestuous, relationships with other currencies. The bully on the block is the U.S. dollar, and the U.S. dollar index shows a recent resurgence in strength.
We have inverted the scale on the weekly Euro-dollar chart and this highlights the degree of similarity between the US Dollar index and the Euro-Dollar chart. The two charts have a high level of agreement. The strength in the U.S. dollar index shown with the rising trend line A is matched exactly by the timing and degree of slope in trend line A1 on the Euro-dollar chart.
The longer term decline in dollar strength shown with trend line B is exactly matched in slope and duration with trend line B1 on the euro-dollar chart. The significant trend turning points, the double top patterns, all match the behaviour of the U.S. dollar index. The closeness of this inverted relationship is more difficult to see when the euro-dollar chart is displayed with the scale not inverted.
Is this analysis valid?
A simple test using an Australian dollar and U.S. dollar index chart shows a different relationship. There are significant periods of divergence in trending behavior which suggests that Australian bank and economic circumstances are an important factor in Australian dollar behavior. The dollar index has changed by 7.4% starting December 2009 and ending March 29. During the same time period the net change in the Australian dollar is less than 0.05%. This divergent trend behaviour does not exist with the relationship between the euro-dollar and the dollar index.
Despite the wringing of hands and gnashing of teeth, the weakness in the euro-dollar is significantly driven by the strength or weakness in the U.S. dollar index. Daily fluctuations are created by the short term responses to news stories from Europe, but the longer term trending behavior is directly matched to the behaviour of the U.S. dollar index. There are trading advantages in following the relationship between cause and effect when it comes to analysing the euro-dollar.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –. He is a regular guest on CNBCAsia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.
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