A Tale of Two Bands: Euro & Dollar

The euro has been steadily gaining ground against the U.S. dollar over the past two years, up 22 percent. But the euro of late has been under strain as the prospect of higher U.S. inflation and support for a stronger greenback sinks in. So what direction is the Euro/Dollar heading in?

Dollar and Euro
Dollar and Euro

The Euro/Dollar chart is a tale of two bands. It can be the best of times, and the worst of times, depending if you are long or short.

The first and most obvious band is the well defined trading channel. The lower edge of this channel has provided reliable support since August 2007. The upper edge of the channel started life originally as a support level during the initial Euro/Dollar breakout in February 2007. Now it provides a cap to the upper edge of the channel.

This first trading channel contains the trend rise. Past behavior suggests a series of tests of the lower trend line followed by a successful move above the resistance level at $1.58.

A move below the lower trend line signals the first major change to the trend in 18 months. Moves above the upper trend line signal short term excitement and confirm trend continuation.

It's not a particularly exciting chart unless you went long near $1.34 – the best of times.

guppy euro dollar.jpg

The second trading bandis created by the sideways movement within the up sloping trading channel. There are two strong examples of these bands. The first is at point A. The upper and lower edges of this band are defined as short term support and resistance levels. The width of this band is measured, and then projected upwards to give a new upside target. We use this projection method to set indicative targets. This is not an exact measurement.

The level of projection will depend on where you place the support and resistance levels. However, this projection method provides a broad analysis tool that helps to define the potential upside when the Euro/Dollar breakout in March 2008.

Area B shows the same sideways pattern development. The trading band finds support near $1.54 and resistance near $1.58. Applying the same trading and projection methods we have an upside target of around $1.62. If a fast rise was to develop, similar to the breakout in March 2008, then the upper trend line would provide resistance around $1.62.

It is tempting to wrap thus bundle of matching projections and turn it into a prediction. This is an incorrect application of technical analysis. There is a high probability a resumption of the uptrend in the Euro/Dollar will find initial resistance around $1.62. Past behavior within this trend suggests that once reached, and surpassed, the $1.62 level will become a new support level. The confluence of common trigger points, reached using different analysis methods, does increase the probability the analysis is correct.

The same analysis methods are applied for the downside. A move below the trend line signals an end to the uptrend. The first level of support is provided by the upper edge of the consolidation band in area A. The behavior of the March 2008 breakout suggests that a fall below the trend line and support at $1.54 could move rapidly towards $1.49.

The two types of trading bands are used to identify the trigger points in the trend where there is a reduced probability of trend continuation and an increased probability of trend change. As the market approaches these levels traders are more alert to the potential for change. Our task is not to know the future, but to manage the future.

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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