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Follow the Money: EuroDollar at Critical Juncture

|Includes: SPDR S&P 500 Trust ETF (SPY)

After a 12% nearly vertical run to new highs in the SPX every trader and investor is asking whether the markets can continue higher or whether we are at or near a top of some kind. For some time I have been using intermarket analysis to help gauge market trend. In particular I have been tracking the relationship between the forex and equities markets and found that a "follow the money" approach is very useful.

It's interesting that the intermarket relationship between key currency pairs has gained favor very recently with much chatter now anticipating a "decoupling". Thusfar there is a tight relationship between a declining dollar and rising risk asset prices and vice versa. The EuroYen also trades in the same pattern. I do note that this relationship formerly displayed a significant lag of some weeks to even a month or more but has become virtually lockstep of late. This could indeed signal a decoupling may be in the offing.

A look at the EuroDollar reveals that this market is at a key juncture and an important move should materialize sometime in the next few weeks if not sooner. If the existing intermarket relationship holds then the future of the rally in equities will be written on this chart. If decoupling does ensue, there will still be valuable information to be gleaned from keeping a keen eye here. Let's have a look at a long term daily chart:

 

The predominant features of this chart are a double bottom in October and February, a huge cup and handle formation within a rising triangle formation and a bullish 50/200 EMA crossover with the 50 EMA providing recent support. RSI is positioned in somewhat neutral territory.

The triangle pattern is often a bottoming pattern but can also be a continuation pattern. The Cup and Handle pattern is among the most reliable and most powerful when it completes. As we can see there is some risk of a break of the uptrend off the February low should the Euro lose the 1.40 level. This would potentially negate the triangle bottom pattern but a further break below 137.50 would be required to call the cup and handle into question. Surely price could spend some additional time within the range of the handle and a false break of the uptrend could then reverse to the upside strongly for a breakout of the cup and handle neckline. It's just like a market to fake traders out of their positions and whipsaw in such a way! In many ways I regard this as the most likely outcome, given the extremely overbought condition of the equities markets and the unlikely prospects for an immediate decoupling. There is also an argument to be made for an immediate breakout. We have been consolidating for a week right at the neckline after breaking out of an intermediate term consolidation triangle. A break higher would lead to substantial and rapid upside as shorts cover and sideline longs jump on board. However, once again there is the overbought condition of the equities markets to consider.

Overall, one gets the sense that a pullback into the handle formation coincident with a retest of recent levels on the SPX on some profit taking is the most likely scenario. In either the bullish or bearish case, this chart provides us with some key technical levels which need to be watched.

Let's take a closer look at the daily chart:

 

Here we can see how very close price is to either breaking out or breaking down from the apex of this huge triangle formation. Also note that the open and close prices for the last 5 candlesticks are almost all at the exact same level of 1.42. Clearly lots of energy is being stored up in this area and will be released one way or another. The failure of the Euro to break higher above resistance during a breakout week to new highs for the SPX should be noted. It raises a caution flag for equities and counsels patience for a pullback before initiating any new long positions.

Let's zoom in further at the hourly chart:

 

We can see that the hourly uptrend has been broken and the break has been retested which further suggests some additional backing and filling may be needed before the Euro breaks out. Again, a move below 1.42 is likely to open up selling to 1.40 or even 1.3850. These levels should provide a good entry point for an initial lot. I will be looking to let price test 1.40 and see how the market reacts. If that is a true support level any break of 1.40 should be bought with great zeal as buy stops are triggered and traders reverse. This level also corresponds roughly with the 50 EMA which is currently at 1.3975.

Let's take an even closer look at the 15 minute chart:

 

Fascinating. This market is straddling the highway with both thumbs out looking for a ride out of town. Will the bulls pull over first or will it be the bears?

Here we have a megaphone or broadening top pattern with price settling down in the exact middle of the pattern. It's worth noting that although the cup and handle was voted the pattern most likely to succeed the megaphone pattern was elected least likely to be useful. However we do see a symmetrical triangle consolidation formed by some significant whipsaw action over the last two days as this market seeks a resolution from the megaphone. My guess is price will visit the bottom trendline of the megaphone around 1.4075 before reversing sharply or will breakdown to visit the lower levels mentioned earlier.

So in summary what is the picture? We have price at the apex of a major triangle formation consolidating just below the neckline of an equally significant cup and handle pattern resting just above an important intermediate uptrend line yet below a shorter term uptrend line and right in the middle of an inconclusive whipsaw megaphone topped with the cherry of a short term symmetical triangle. Friends, if that's not a move ready to happen then I don't know what is!

Knowing that some good action is imminent, we can prepare to profit from it. Similar analysis could be applied to the USD index and all it's major currency pairs with similar conclusions drawn.

I'd like to thank myself for patiently stalking the recent Loonie breakout and catching a very nice move and flagellate myself for exiting too soon and even trying to short the rise.

Feedback, comments, slams and accolades are welcome.