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Week of November 10, 2008

EURUSD remains in a medium term consolidation pattern as evidenced by the recent lower highs and higher lows, while currently trading within a symetrical triangle or pennant formation (more of the difference below between these two in the below text) as defined by the upper descending trendline and the lower ascending trendline.  The pattern must contain at least two lower highs and two higher lows as the upper trendline points are the October 30, 2008 high at 1.3298 and the November 5, 2008 high at 1.3112, while to the downside, the lower trendline points are the October 28, 2008 low of 1.2328, the November 4 low at 1.2525 and November 7 low at 1.2652.  Today’s upper trendline comes in at 1.2989 and the lower at 1.2716.

By connecting the lower highs and higher lows, the trend lines extend and the triangle pattern takes shape. You could also think of it as a contracting wedge, wide at the beginning and narrowing over time.  As the price action consolidates over time, sellers begin to sell at lower highs while buyers begin buy at higher lows.  Eventually, one group overwhelms the other and the result is a dramatic breakout, with the momentum and duration of such breakout directly proportionate to the duration of consolidation.

Below I have listed essential triangle or symmetrical triangle pattern criteria, all of which apply to the current pattern EURUSD pattern best viewed on the 4 hour chart.
1. Trend : In order to qualify as a symmetrical pattern, an established trend should exist. The prior trend should be several months old and the symmetrical triangle marks a consolidation period before continuation or trend reversal. The EURUSD trend was in a bearish trend prior to this consolidation pattern and has essentially been in a consolidation patten when since November 4.
2. Four (4) Points : At least 2 points are required to form a trend line and two trend lines are required to form a triangle. Therefore, a minimum of 4 points are required to begin considering a formation as a triangle. Ideally, the breakout occurs after 6 points (3 on each side).  At this writing there are 3 lower points and 2 upper points.
3. Volume: As the triangle extends and the trading range contracts, volume begins to diminish. Such has been the case the last few days. This is known as the quiet before the storm, or the tightening consolidation before the breakout.
4. Duration: The triangle can extend for a few days to a few months and is directly related to the recent trend.  In this case,  the EURUSD reached a low of 1.2328 on October 28, 2008 and corrected to 38.2 of the 1.4866-1.2328 fall at 1.3298.  If the pattern is less than 3 weeks, such as the current formation, it is usually considered a pennant and almost always results in a continuation of the prevailing trend.
5. Breakout Time Frame: The ideal breakout point occurs 1/2 to 3/4 of the way through the pattern’s development or time-span. The time-span of the pattern can be measured from convergence of upper and lower lines. A break before the 1/2 way point might be premature, as occurred on the June 6, 2008 pattern break, while a break too close to the apex may be insignificant.  After all, as the convergence of the trend lines approaches, a breakout must occur.  Going back the October 28, 2008 low, the current pattern is already 3/4 complete and a break out will certainly occur within the next 72 hours from this writing.
6. Breakout Direction: The future direction of the breakout can only be determined after the break has occurred. Sounds obvious enough, but attempting to guess the direction of the breakout can be a bit tricky. However, the medium and broad term trend remain to the downside and short term consolidation patterns such as the one unfolding now, are usually continuation patterns.
7. Breakout Confirmation: For a break to be considered valid, it should be on a closing basis with a price (3% break) or time (sustained for 3 days) filter to confirm validity.  However, in that the current pattern duration is more short term, any sustained move above 1.3053 or below 1.2556 at this juncture will see further extension in the direction of the break.  As the breakout unfolds, an expansion in volume will occur.  Additionally, as often occurs, once prices break above or below the trendlines, a retest of the trendlines as support or resistance may occur.

8. Return to Apex: After the breakout (up or down), the apex can turn into future support or resistance. The price sometimes returns to the apex or a support/resistance level around the breakout before resuming in the direction of the breakout. Two points of interest here are the October 28, 2008 low at 1.2328 and the October 30, 2008 high at 1.3298.

9. Price Target : There are two methods to estimate the extent of the move after the breakout. First, the widest distance of the triangle can be measured and applied to the breakout point. Second, a trend line can be drawn parallel to the pattern’s trend line that slopes (up or down) in the direction of the break. The extension of this line will mark a potential breakout target. Using the parallel trend line method, the initial upside target price is 1.3597, and to the downside, the target is 1.2003.

Conclusion: The current consolidation pattern is nearing its end, with potential for a breakout to occur within the next 3 days.  Finally. this pattern has a very reliable history as seen in previous breakouts which occurred in 1995 when after the symmetrical pattern, the US dollar rallied for 10 months, in 1996, after the symmetrical pattern consolidated for 5 months, the US dollar rallied 10 months, in 1998 when the US dollar rallied 26 months (wave 3), 2002 when the euro rallied for 36 months, and finally in 2005 the US dollar rallied for 8 months, and in 2006-2007 when the EURUSD rallied for 12 months, all subsequently to triangle consolidation patterns. However, all of the above examples occurred afer significant consoldation for several weeks, whereas the current pattern’s duration is just a few days. As stated earlier, there is a direct correlation between the duration of the pattern and the intensity of the break.

More updates later.

  • Posted by adminfx
  • On November 10, 2008
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