Expectations that the Federal Reserve will hike interest rates in the first half of 2015 coupled with concerns about the health of the euro zone economy are weighing on the euro/dollar, but as key technical levels are achieved charts raise an important question: Are we looking at a breakout or a continuation of the downtrend?
When the euro/dollar fell below $1.34 at the beginning of September we set a down side target at $1.28. This was achieved and exceeded; the pair is currently testing $1.28 as a resistance level.
The euro/dollar has traded between two broad trading bands since September, 2012; the $1.34 level is in the middle of this trading band.
The upper edge of the trading band is near $1.40; this level was defined by support and resistance activity in 2010 and 2011. Starting September, 2013 the euro/dollar traded in the upper section of the trading band between $1.34 and $1.40. In May, 2014 the pair briefly touched the upper level of the trading band and then started a prolonged downtrend. The downtrend is defined by trend line A. The pair must move above this level, currently near $1.30, before a new uptrend is established.
The width of the upper section of the trading band is projected down to set the lower edge of the trading band near $1.28. This level provided support in November, 2012 and in March, May and July, 2013. It is a significant and well-tested support level.
The same method of band measurement and projection is used to set the next support target near $1.22. However, there's a problem with this projection. Unlike the $1.28 level the $1.22 level does not have a strong historical pattern of support. It acted as a support region in July 2012 and June 2010. There is a reasonable probability of a dip towards $1.22, but traders' attention is focused on the stronger $1.28 support and resistance level.
Dips below from $1.28 are likely to be temporary as the euro/dollar establishes a consolidation near $1.28. The key feature for any uptrend recovery is the ability to move above $1.28 and then use $1.28 as a support level. This behavior confirms the beginning of a trend breakout. This is confirmed if the market is able to move above the value of downtrend line A. Any future rebounds from $1.28 will first find resistance at the value of the downtrend line and then at the long-term support resistance level near $1.34.
In the short term, traders will trade from the short side and follow the downtrend move with a potential test of $1.22 support.
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.