Elliott theory suggests downward ride

The Australian dollar has been the bellwether in the recent battle between the Reserve Bank and international investors looking for somewhere safe to park their money. When interest rates were relatively high, the Aussie was uncharacteristically hovering above parity with its US counterpart, a reality that caused considerable pain to non-resource exporters and local manufacturers.

The RBA, fretting about the effects on the real non-resource economy, has cut official interest rates consistently since November 2011. But not until this May, when the rates fell to 2.75 per cent, did the currency take a serious and sustained tumble below parity.

As this week's chart, produced by Philip D'Souza, a member of the Australian Technical Analysts' Association, shows, the Aussie fell 20.14 per cent from its post-float high of $US1.108 to its nadir of $US0.8849 after the RBA cut rates to a record 2.5 per cent.

Since then, the currency has come back a little and broken through a resistance level of $US0.9318, which appears to have now turned into a support level. We now draw on Elliott wave theory, which indicates that the future direction of the Aussie is downwards.

This negative outlook comes with the transposition of a five-wave Elliott pattern on to the chart. The first wave is the downward red line on the chart marked Wave 1. The second is the green upward line marked as Wave 2. The third long red downward thrust is Wave 3.

To stay within Elliott theory, the fourth wave is said to have begun and should be an upward green line. So far so good on that (remember, the chart is a weekly one so it does not show recent daily fluctuations).

D'Souza says to stay within the five-wave Elliott pattern the currency will move into the territory of the three blue lines marked Wave 4. The first would represent a retracement of 38.2 per cent from the total decline in Wave 3; the second a 50 per cent retracement; and the third a 61.8 per cent retracement. As the market breaks through any of these levels, the one above will be the next resistance level.

Resistance at any of these levels could see the currency fall back to fulfil the fifth downward wave and close out at or below the August 9 low of $US0.8849. If the currency were to move back into the price territory covered in Wave 1, the pattern would be broken and further rises could follow.

Just to fill you in on some rules around what makes up a five-wave Elliott pattern, Wave 2 cannot move higher than the peak in Wave 1. The downward magnitude of Wave 3 must be longer than both Wave 1 and Wave 5, and Wave 4 cannot make a daily close within the territory traversed by Wave 1.

Those wanting exposure to the Australian dollar can use futures, options, exchange-traded funds and contracts for difference, along with the standard forex market.

This column is not investment advice. Contact Rod Myer at rodmyr@gmail.com

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