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Wednesday, 19 May 2010

The ES Broadening Bottom and USD Currency Pairs

Yesterday's early bounce failed at the key resistance level I mentioned yesterday morning, which was the top trendline of the broadening bottom on ES, and it fell most of the way towards the lower trendline over the rest of the day. After a very weak close, it has fallen further overnight to well below Monday's lows.

As it is still very clearly the dominant pattern here I'll be focusing on the broadening bottom today. Here is where we are on ES at the time of writing:

The first thing to note about this particular pattern is that it is a monster. If it was to break up from here without touching the lower trendline it would indicate to 35 points higher than the top trendline of the pattern. As soon as we have a hit of the lower trendline of the pattern though, currently at 1093, then the breakout target would increase to 54. If we were to break up from (say) 1160, that would indicate almost to new highs, and if we were to break down from (say) 1080 that would indicate to 1027. This is now a very big pattern.

The lower trendline of the pattern is currently at 1092, and won't be lower than 1088 if we hit it today. If we get that far then we should expect a bounce there, as even if this pattern is going to break downwards, there is a reasonable expectation of a partial rise from the trendline and then a return to break through it.

Even though this pattern is called a broadening bottom, these break upwards only 53% of the time. A partial rise and return to the lower trendline would indicate a 67% probability of a break downwards, but if we do break downwards, there is only a 44% chance of meeting target. This is not a high probability pattern on a downward break particularly.

As with all patterns and channels, if we hit the lower trendline, we should watch carefully to see whether an IHS is forming. If we are to see a good bounce, then there is a better than 50% chance, in my experience, that we will see one form. If we are to make it back to the top of the pattern, then it will most likely be a big IHS, and I can see now that we have formed a possible left shoulder to such an IHS overnight.

As ever these stats come from Bulkowski's excellent website.

Now the inverse correlation between USD and equities is not what it was. When USD bottomed in November the SPX was trading in a rectangle between 1085 and 1115. Now that USD has rallied almost 18% we are still near the upper end of that SPX range. That said, there has been a strong correlation in the meantime in that while USD has been in a strong wave up, equities have either traded sideways, or corrected down. While USD has been trading sideways or down, equities have rallied strongly.

That matters, as USD has been in a very powerful wave up since mid-April, accelerating powerfully in the last two weeks particularly. At some point this wave up will finish, and if the correlation remains the same, we will then see a powerful rise in equities.

The most important of the USD currency pairs is obviously EURUSD, and in recent days that has met the rising wedge target just about 1.25, and has since hit my broadening descending wedge target at 1.215 overnight. Unless EURUSD is in freefall now, which is definitely possible, then we should be close to an important reversal point:

GBPUSD has also been sold off powerfully and I have been having a very careful look at this on the weekly chart. Again we have a broadening descending wedge and my target if it should be hit this week is 1.408. If it is hit next week it will be at 1.40, which is the key long term support level for GBPUSD. At minimum we should see a powerful bounce there and I will be a buyer of GBPUSD if and when that level is hit:

Of the commodity currency pairs, I posted on 21st April that AUDUSD, which was at 93 at the time, had a very good chance of falling ten cents or more to a target of 81.5 within a right angled and descending broadening formation. As I write AUD has been below 84 overnight, and there is a good chance now that it will make that target. Naming no names, there were a couple of bloggers who suggested that my AUDUSD target was ridiculous at the time I posted it. Hopefully they didn't go long. :-)

There is another target to consider as well though, and that is the 62.5 target from the rising wedge that defined the last major upswing. These wedges are indifferent performers on equities, but are very good performers on currencies. If AUDUSD breaks down from the broadening formation, the target for the next decline would be 69.5 and while I'd hesitate to go long at 81.5, this would look like a very appealing short on a weekly close below 80.5. If that pattern target at 69.5 was reached then the rising wedge target at 62.5 might well also be reached:

The real question for AUDUSD of course is what is likely to happen on commodities. I've read quite a few posts in recent days about how oil is now near the bottom of the trading range for the last year, but that isn't what I see on the weekly chart at all:

It looks clear from the chart that oil has been in a gently rising channel for the last year, and that the channel is now broken. Unfortunately there are no downswing targets from a broken channel, but this could well be the beginning of a very major reversal. If it is, then we could see oil fall a long way from here and the same applies to most of the other commodities with the possible exception of the precious metals. That would put the commodity currencies under at lot of pressure and we might then see that rising wedge on AUDUSD play out to target.

As ever, time will tell.

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