Amid resurgent volatility, Kaye Lee of StraightTalkTrading.com presents a pair of very different Euro set-ups, one a trending long entry in EUR/AUD and another a potential reversal in EUR/USD. 

Markets had been reacting somewhat haphazardly of late. That is, until this swift and sharp decline in world equities has begun to roil currency markets as well. It’s a result that is neither surprising, nor especially undesirable for currency traders given that times of great momentum and volatility also produce the highest potential for gains. The question that is worth asking, therefore, is where renewed opportunities in forex are actually occurring?

Although this article is primarily about currencies, it is also important to keep an eye on world equity markets, as they are all inextricably linked to one another. As the below chart (Figure 1) shows, the major stock markets of the US, Germany, and Japan are all moving down with a vengeance on the weekly charts. Those who are looking for longs here would likely be better advised to step aside until this momentum climaxes, as buying now would be like the proverbial act of trying to “catch a falling knife.”

Figure 1: US, German, and Japanese Equity Declines (on Weekly Charts)1

Although all three of these markets are at levels of support, momentum is likely to completely overwhelm these zones, or at least make it difficult for bulls to stage an equally sharp and sudden reversal. Thus, it is better to be patient until bottoms form, or at least until downside momentum shows signs of fizzling out.

In light of that warning, however, traders may be able to catch a potential top in EURUSD, and for starters, this is why: Unlike equities, EURUSD has been moving up with far less fervour, a point which can be readily seen on the below weekly chart (Figure 2).

This point is likely to have been missed by those who are focussed on the lower time frames, but it is a point of utmost significance, as it suggests that although the equity and currency markets are linked, the correlation is not functioning perfectly at this stage.

Figure 2: EUR/USD Momentum Is Far Less Convincing2

In periods of increased uncertainty, the usual flight is to the safe-haven currencies like the US dollar (USD) and Japanese yen (JPY). If that were true this time as well, then GBP/USD and AUD/USD (and indeed EUR/USD) would be headed in the same direction. Currently, however EUR/USD is up, GBP/USD is up to a lesser degree, and AUD/USD is decidedly down. In other words, the reaction in the US dollar, which is usually consistent, is not congruent in this instance (see Figure 3 below).

Figure 3: A Traditional US Dollar (USD) Correlation That’s Failed3

In addition, USD/CAD (shown above) and USD/CHF (not shown) should be inversely correlated with those currencies, and behaving like one another, although neither is happening right now. To sum it up, the markets are confused, and in confusion, there could be profitable opportunities.

There are two strategies to consider:

Pursue trending opportunities, the most notable of which is now occurring in EUR/AUD. For all time frames lower than the daily (shown in Figure 4), the strategy should be to buy dips on trend continuation patterns. The sheer momentum on the daily chart should ensure that the market is likely to be lenient, even on less-than-perfect entries.

Figure 4: Buying Dips on EUR/AUD4

The second strategy is not for the faint of heart. It follows the logic that if the USD reaction is inconsistent, then the market’s confusion will resolve itself at some point, and most likely sooner than the equity markets.

Actually, the mere fact that EUR/USD is headed higher is somewhat suspicious by itself. Afterall, a drop in equity markets should more than likely produce a flight to safety and dollar-based assets. Thus, we will be looking for signs of a reversal in EUR/USD, back down from the Blue Box (see figure 2 above) at 1.1680-1.2078 once it is breached, an event that should occur within the next few days.

Trades will mostly likely be based on four-hourly chart reversal patterns. This is the lowest time frame that’s viable for reversal trades since going any lower will likely result in stop-outs while the bears struggle to control momentum.

By Kaye Lee of StraightTalkTrading.com

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