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Why the Dollar rally wasn’t a surprise

The EUR/USD finally peaked in mid-2008 after a powerful 5-wave rally which brought the price to 1.60. At that time almost no one was bullish about the US dollar- an indication that an actual top was in place. Remember, price extremes are a manifestation of mood extremes. The EUR/USD wasn’t an exception of the rule and a reversal followed as shown at the chart.

eurusd

The Elliott Wave Theory suggests that 5-wave rallies are followed by a 3-step style correction (A-B-C). At the end of the correction the public will express the opposite type of mood- be extremely bullish about the US dollar.

After the top of 2008, a quick reversal followed which coincided with the peak of the financial crisis. The reversal was abrupt and unexpected by the public. It should be marked as wave A. The size of wave A was approximately 3800 pips. Remember this number!

Once wave A was completed, a counter trend rally (wave B) followed which took the shape of a running triangle. Triangles are information-rich trend continuation patterns. The main trend resumes after the the triangle is completed. Though the trend continues, triangles are also an indication of a terminal thrust of the trend, i.e. a trend reversal should be expected. Finally, triangles can be used for setting the price targets.

The only problem with wave B was its duration. It lasted for 5 years. During wave B traders and investors were challenged because of the lack of a clear trend. The peak of the frustration occurred at the end of sub-wave e when the market volatility reached a multi-year minimum. Savvy traders, however, know that periods of low volatility are very often followed by sharp and breath taking moves. This is the case with wave C so far.

Wave C has brought the price from 1.40 to 1.11. Short positions were opened in December 2013. For those, who are considering purchasing US dollar, a buy recommendation can be proposed, although the risk-reward ratio is already quite unattractive. Yet, there are no indications for a bottom which provides some trading opportunities for the time ahead.

There are several scenarios worth being considered when assessing the end of wave C. First, theory proposes that wave A is often equal to wave C. If this is the case, wave C should be 3800 pips in length. Thus, the profit taking level is expected to be in the area of 1.02 (near parity), or 1100 pips lower than the current price. The second scenario is based on the information provided by the triangle. A parallel line is constructed starting from the bottom of wave b of the triangle. The line is parallel to the top triangle line (marked with a dashed line at the chart). This projection suggests the end of wave C has already occurred.

The best way of indicating a market bottom, however, remains to count the sub-divisions of wave C. Wave C should have 5 sub-waves in order to be completed and call a final bottom. The next post will focus on the structure of wave C in more details. So far, evidence suggests that wave C is only partially completed and there is a significant downside potential.

Moreover, at the bottom, the “fundamental” analysis should suggest a gloomy picture about the Euro. Probably, Greece or another peripheral country will exit the Eurozone, the recession will be back and there will be absolutely no reasons to buy the Euro. Many analysts will expect the death of the Euro. All of these are manifestations of the negative social mood that prevails at a multi-year market bottom. Although the sentiment towards the Euro has been deteriorating (typical for wave C), mood extremes have not been reached yet, which supports the hypothesis for a further downside potential.