18 June 2010

EUR Directions

EUR/USD consolidated and equities stayed in the range: 6/18. The ideas in 'Trading Chaos' are exciting but they have problems in forex, those divergent bars turn into something else a lot of the time.

The probe I mentioned during the week is a key form of this. It is a spike which bounces then finds the value the spike was probing, it is the death of divergent bars and stop-losses. It usually happens while the market is testing a key technical level.

A bullish divergent bar is driven by short covering, but if the short covering is technical, i.e. driven by buy orders at a key technical level, whatever was driving the price down can reassert itself. The forex market is technical but the problem is it is driven by external fundamentals a lot of the time as well. This makes for its difficulty and the way it becomes a zero sum game.

Key technical levels usually have large reverse orders to the trend, which bounce the valuation. But the market then finds the value. That is the problem with divergent bars, probes look like them, until it is too late (you get stopped out if you placed an exit at the bottom or top of the spike).

Filtering with Raghee Horner's 34 EMA does not help in this case, as these are movements which crash through the 34 EMA. However there are signs, usually they have an unusual volatility associated with them (hence the divergent bars becoming probes) and a greater than average bounce around the technical level (for example a '00').

They are also associated with fundamental surges behind them, like equities crashing. The question for Euro, is what fundamentals support a true reversal ? What is valuing Euro, not the fiscal health of Europe...is it $ being kept at near zero rates ? The world is afloat on this imposed valuation on $, which the market has valued as much as it can. This is I believe the true source of the valuation shocks of recent months.

If the market is being pushed for technical reasons in a given direction supported by an official policy of effectively removing interest rates as a valuation method, what happens when the fundamentals reassert themselves - well, it seems huge revaluations. It was standard analysis at the time, EUR/USD would breach 1.5 and continue ahead. But it didn't, look where it is now.

It didn't for a number of reasons, one of which were government comments and then the issues with euro debt, but the idea of interest rates rising seemed like the real cause. But they haven't been raised yet and there has been constant reassurance, except for that indication a few months ago, they won't be.

Technically EUR/USD can continue up (but that consolidation I saw in 1 day has produced a double spike top on the 4 hour, but rising equities provide elements of support, note how equities can dampen momentum, like a calm sea: 6/21), but is there another fundamental reassertion somewhere waiting ?

What happens when interest rates rise - it is the huge fundamental waiting. Perhaps it has already been valued in. But still, what happens when it is no longer possible to borrow large sums of $ at very low interest rates to invest in commodities and equities ?

The solution to all this is the recovery, because this will take over from the money flow sustaining the value of financial instruments, revenues increase, shares rise, all back to normal. That one assumes is the theory behind all this.

UPDATE COMMENTARY 03/05/11: The behavior of EUR since this post supported the above analysis.

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