Could the euro defy conventional thinking?

Consensus opinion sees the euro weakening further against the US dollar. But there's a chance a corrective rally is on the cards.

The relative merits of technical and fundamental analysis has traditionally been a tribal debate among market types. It’s been somewhat less of an issue in recent years, with more investors and traders using both methodologies.

However, in a room full of traders it’s usually not too difficult to get a discussion based on deeply held tribal beliefs underway.  It’s a bit like dinner party climate change arguments. The phrases ‘voodoo finance’; ‘efficient market theory’ and ‘it’s all too subjective’ will feature along with liberal use of competing academic studies. You can find credible academic analysis together with case studies of long-term success to support either tribe. Naturally, it’s never a problem coming across examples of failure to employ as anecdotal evidence that the other tribe’s methods just don’t work.

So what’s an investor or trader to do? Perhaps the real key to success comes from combining good strategy and risk management with sensible and well understood market analysis that’s suitable for your purpose. For private investors doing their own thing, the latter requirement means having good access to education as well as the time to properly do the sorts of analysis you favour (a strong interest also helps).

The euro and conventional thinking

One advantage of thinking about markets in terms of charts as well as fundamental drivers is that the two forms of analysis can be complimentary. Technical analysis can alert you to situations where markets are more than usually vulnerable to contrarian news or even to just a period of not much news at all.

EUR/USD

The EUR/USD looks as though it might be in that position now. Consensus opinion sees fundamental drivers pushing the euro lower against US dollar and this looks sensible to me. The European economy is a lot weaker than the US’. The US Federal Reserve is likely to begin increasing rates this year, while there’s a significant chance the ECB will end up having to go the other way, adding to its QE program before it’s over. The euro also remains vulnerable to negative shocks, with the treatment of Greece’s debt now up for debate.

Yet on Monday, the euro made a low right at technical level, based on the theory of harmonic chart patterns. This says that markets often move in three swing (or ABCD) patterns where AB=CD as shown on the chart below.

Looking at a weekly chart like this, you need individual candles to start making both higher lows and higher highs to say a trend has changed from down to up. This won’t happen until next week at the earliest.  To reject this AB=CD low with a trend change, the market will need to stay above this week’s low and then move above this week’s high. If EUR/USD just keeps falling next week, there will be no trend change and no rejection of this level on the big picture weekly chart.

However, if the weekly trend does change, leaving 1.1098 as a low, this chart pattern says to me that, despite my consensus fundamental view that EUR/USD is headed lower; the market is ripe for a corrective rally. This could be surprisingly large and extend beyond the bounce we have already had.   

Technical and fundamental analysis by Ric Spooner, chief market analyst at CMC Markets. @ricspooner_CMC