Daryl Guppy

Euro buys a dead cat bounce

By Daryl Guppy (China Daily)
Updated: 2010-05-31 10:26

The euro has shown it was able to buy a dead cat bounce with a short-term euro/dollar rally from 1.22 to 1.27. The political announcements from a variety of European leaders were not enough to change the direction of the euro trend. This is relentless downward pressure toward historical support levels.

The currency speculators were ecstatic with political statements that "We will do whatever it takes" to protect the euro. It was an invitation to short the currency and financial institutions. Currency trading and trading related to financial institutions are two different market areas with very different behaviors.

Consider financial institutions. Taking a short trade in relation to a bank does not start a downtrend. A short trade is taken when a downtrend has already begun. It's a directional trade, exactly the opposite of a trade taken in a rising trend. Many people think the short trading starts the downtrend but this is not correct. A successful short trade is created when a downtrend is already in place. Creating limits of short selling will not make the problem of trend weakness disappear.

Currency markets are different because they are constructed by many willing and unwilling participants. When a European importer buys goods from America then the buyer's bank must take the opposite side of the currency transaction. They have no choice. One side of the transaction is automatically long and the other side automatically short. In this sense, short trading will always exist in a currency market.

It is useful to step away from the political statements in Europe. The euro/dollar reaction is part of a wider picture of market fear that also brings us the current weakness in the Dow and other markets.

Related readings:  Euro, stocks rally as China reassures investors  Germany should get out of the euro and leave markets in peace  Euro set to fall even further on debt crisis  'Uncertainties' damage euro's value

Strategic analysis is as important and from a charting perspective this calls for a monthly chart where each candle represents a month of trading. The advantage this view comes from the way it highlights the skeleton of the market.

Support and resistance levels in particular are clearer. Broad trading behavior is also clarified but it is the movement between support and resistance that is more useful because it suggests limits on the euro fall and limits for any rebound.

It is more difficult to see exact values with a monthly view. Traders use a daily chart to ready themselves for action if a support rebound develops. These are areas of high probability in terms of developing the conditions necessary for a trend rebound, or a trend continuation.

The author is a well-known international financial technical analysis expert