June 25th, 2008
The EURUSD has remained in a broad consolidation pattern since the April 22, 2008 high at 1.6017, as chart patterns and price action strongly suggest a breakout is imminent. The catalyst for such a breakout may occur today with the FOMC rate decision at 2:15 PM EST. The Fed’s easing cycle should have ended in May with the 25bps cut as the Fed is widely expected to be on hold at 2.00% today. However, recent hawkish statements from Fed speakers suggest rate hikes are likely from the Fed later this year as the Fed attempts to slow inflation risks which are primarily due to skyrocketing food and energy prices. Markets are expecting a 25bps hike in September, with a 80% chance already priced into interest rate futures.
The current consolidation pattern of the EURUSD is similar to a symmetrical triangle pattern. This pattern has unique characteristics as I will describe below, and ALWAYS precedes a major market move.
The symmetrical triangle usually forms during a trend as a continuation pattern, but can also mark the beginning of a trend reversal. The trend prior to the triangle was EURUSD bullish.
The pattern must contain at least two lower highs and two higher lows, as the lower highs occurred on May 27, 2008 at 1.5818 and June 20, 2008 at 1.5651, and the higher lows occurred on May 7 and June 13 at 1.5283 and 1.5302 respectively. On June 6th there was a false breakout due to some very hawkish comments by ECB president Trichet, but the knee jerk reaction was short lived as prices quickly fell below trend line resistance. (See #5 below)
Now as you connect these lower highs and higher lows (disregarding the June 6 false break), 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. Now, as the price action consolidates, 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.
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 bullish trend prior to this consolidation pattern and has essentially been in a multi week consolidation patten since the April 22, 2008 high.
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).
3. Volume: As the triangle extends and the trading range contracts, volume begins to diminish. Such has been the case in recent weeks. This is known as the quiet before the storm, or the tightening consolidation before the breakout. Overall, volume has been very thin for all of May and June, as evidence by brief market spikes with little to no follow-through price action. Traditionally, volume has been light in the 1st two quarters for the last few years, as volume tends to increase in the 2nd half of the year.
4. Duration: The triangle can extend for a few weeks or many months and is directly related to the recent trend. In this case the EURUSD reached a high of 1.4969 on November 23, 2007 and corrected to 1.4438 on Feb, 7,2008, which then began the rise to the all time high of 1.6017 on April 22, 2008. The recent low occurred on May 8th at 1.5283. If the pattern is less than 3 weeks, it is usually considered a pennant, however in this case the triangle pattern is almost 2 months in duration. Typically, the time duration is about 2-4 months. The current pattern has essentially consolidated since the May 5, 2008 low of 1.5283 or 7 weeks at this writing.
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 June 6) and 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 April 22, 2008 high at 1.6017, the projected time for convergence of the upper and lower lines is 3 weeks from today, as the pattern is already more than 3/4 in duration.
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. At this point, I have no idea as to the direction of the break, but, most patterns of the type 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. The breakout should occur with an expansion in volume, especially on an upside break. On the daily chart, a daily close above 1.5844 or a close below 1.5283 would confirm a breakout has occurred.
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 April 22 high at 1.6017 and May 5 low at 1.5283.
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 1.6147, and to the downside the target is 1.5002, which, is also the 38.2% of the August 2007 low at 1.3359 and the April 22, 2008 high at 1.6017.
Conclusion: All the above criteria have been met with regard to EURUSD, as the current consolidation pattern is nearing its end, with potential for a breakout just days away. 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.
I will have more updates in the days ahead.
Ronnie, FX Strategist
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