The Dow Jones Industrial Average shows a head and shoulder pattern that is very obviously and exciting. It is exciting because traders look at it as a cue for a break down in the market.

In any reversal pattern, the neckline is very important because the break of this line confirms the validity of the entire pattern. This is such an important and unambiguous rule but it is also also a wonder why many traders fall prey to this level. The ones who get it wrong every time are the ones who  play the break of this level. They get killed ultimately by my favorite set-up: the bull and bear trap.

DJIA fails to break support; rebounds strongly

How did it happen? Candlestick tails or breaks in lower time frame charts convince daytraders (mostly scalpers) to short. But price persist here until a good reason causes it to move. Swing traders who respect support and resistance know the simple concept of buy support, sell resistance. They also know that candlestick tails should be viewed with suspicion. When buying finally comes in, price is going to pop like a cork. Buyers go in strongly because by buying support, their risk is very low. They are boosted by hapless sellers who now rush to cover their shorts. Short covering helps to push price further. (Good swing traders also join in here.)

This set-up is so powerful and so predictable that I called it a high probability set-up. In fact, I gave a clue in an earlier analysis, and specially brought it up again in last night’s hands-on session. We use it to trade the forex, futures, stocks and commodities markets.

Experience and discipline helps; I gave a clue in another analysis

To learn everything I said here and much more, come join my FX Tflow® class where I will help you combine theory with actual trading experience. Call +65 6492 3196 to ask for preview sessions.

The EURUSD now has a support zone that had 2 precedents: late March and early April.

While the daily setup continues to be downtrend, bullish players may be hunting for reversal play on the lower timeframes.

Is that a bear trap for the Euro?

The potential morning star on the AUDUSD daily chart points to a bear trap. Although the picture is only complete when the candle closes, a strong bullish momentum is already visible on the 4-hour chart. Before big bears look for a short once more, we need to see a higher pullback so that both the bullish momentum and upside risk can diminish.

AUDUSD regret break of February high

Strong bullish momentum has to diminish before bears take risk

Today, we are analyzing chart patterns in the Dollar Index (USDX) together with the COT Report in order to finds that may tell us where the dollar is going.

Breakout in weekly chart

In my post Reflection on FX Majors with COT Report, we already know that USDX has recently made a breakout of the falling wedge pattern in the weekly chart (See chart below).

We also see that USDX is trading between a recent Resistance @ 78.82 and Support @ 76.22 and is currently near the resistance level.

USDX Weekly Showing Bullish Reversal Breakout of Falling Wedge

Daily Chart – 1. Bullish Flag Pattern

From the daily chart below that there is a Bullish Flag Pattern, which was formed shortly after the breakout from the falling wedge pattern on the weekly chart.

In addition, the flag was ‘resting’ on the 50 day Moving Average, forming a Higher Low, thereby giving some bullishness to the picture of USDX.

USDX Bullish Flag

On the other hand, some might consider another outlook for the USDX in the manner below.

Daily Chart – 2. Bearish Broadening Top Pattern

USDX Bearish Broadening Top Pattern

As from the  chart above, a different way of joining the resistance line gives us a broadening top chart pattern, which might indicate a somewhat bearish view.

The recent shooting star, which happens to be near the previous monthly resistance, adds to the bearish-ness on the current movement. (See chart below)

USDX Bearish Shooting Star Candlestick

There are two pictures now, a Bullish Flag Pattern and a Bearish Broadening Top Pattern.

So how can we resolve this 2 conflicting views? The COT Report comes into the picture.

COT Report Analysis

With reference to the above charts, the bottom panel of the chart maps the Total Open Interest and the Commercial Sentiments for USDX.

We can see that:

• Commercial Sentiments is unwinding their shorts on USDX, which may indicate slightly bullish sentiments.
• The total Open Interest is slightly lower than previous week, which also hints that there is still high interest for USDX, thus, boosting the bullish signal again!

The Euro has reached a key retracement level of its 2009 rally. At the moment, this 38.2% level is a support to watch.

EURUSD retraces 38.2% of 2009 movement

2 conditions give us a clue to whether the the Euro will rally from here or continue on its downtrend in the daily chart. A downward trendline now prints its resistance. As long as the trendline is not violated, the EURUSD will continue to retreat against the Dollar.

But there is another level to watch.

1.4216 is December 2009 low. Based on current price levels, 1.4216 will become a resistance and it comes before the downward trendline meaning that bulls and bears will be fighting this level first. If this resistance is breached convincingly in the near future, the technical picture of Euro may change. This outcome will make price movement below 1.4216 a ‘bear trap’ so that a downward wedge with bullish implications will form.

Critical level in Euro decides downtrend or bear trap

Big moves in the major pairs and crosses were made between Thursday and Friday (26 – 27 Nov 2009). This is a worthy incident to look at and learn from. Lets recall the incident:

• The pairs involved made moves that exceeded their usual daily range
• They show a sudden return of risk aversion
• The Japanese finance minister used the word ‘abnormal’ to describe the market
• Analysts quickly associated the move with stock market sell-off in Dubai; some said it is a blip while others say it ‘has legs’

From a technical point, there are signs of a risk aversion move in currencies prior to the sell-off but the charts also show confusion.

Let’s look at the GBPUSD.

1. A fall in the GBPUSD is a risk aversion move
2. Sterling was resisted by a 6-month level at around 1.67~
3. From the day chart we can see at least two failed attempts to break out
4. By Thursday 26 November 2009, GBPUSD was resisted and suggested a right shoulder of a Head and Shoulder chart pattern
5. The Head and Shoulder chart pattern is usually read by chartists as a reversal pattern
6. This chart pattern can be clearly read in the 4-hour chart
7. By Friday, price has fallen through the ‘neckline’ on the 4-hour chart; falling below the neckline is a confirmation of the validity of the pattern
8. However a long tailed doji or ‘hammer’ look-alike candlestick quickly reversed the move and the neckline was unable to serve as resistance
9. The day chart shows what looks like a failed break

In other words, was there a true panic and reversal? Has this been replaced by regret and remorse?

—

CNBC 27 Nov 2009 – Dubai Debt Woes ‘A Blip’, Won’t Lead to Global Fallout: Strategist

CNBC 27 Nov 2009 – Dubai Stock Market Fear Has ‘Legs’: Dennis Gartman

Marketwatch 26 Nov 2009 – Japan finance minister: forex moves ‘abnormal’

—

Strong resistance for Sterling

Was this a breakout? Is it a bear trap?

This level is the high of the October rally. For now, the hour candles show tentativeness although conclusions can only be drawn when the daily chart give us a significant candle signal.

October high: .9326

Level reached today: .9343

Exceeded by: 0.16%

Traders might be on the lookout for a bull trap as a trigger.

Aussie revisit highTentativeness

Tentativeness

The Aussie has retraced less than on the Euro based withdrawal from the October rally. This is the 50% fibonacci retracement level. It appears to be in a channel this week. Similar to the bear trap that we saw in the Euro two days ago, Aussie subsequently moved to a higher intra-week level although it has not been able to close above that based on the 4-hour chart.

Long term trend seen in the daily chart

Weekly chart shows the retracement, bear trap and subsequent overnight rally

Euro appears to display a failed break on the daily chart. Despite intraday action breaking down the 61.8% retracement of the October rally, the daily candles print a long tail with a close above this support level. This appears to indicate that the support is solid. There may be a re-test to vindicate the support.

Points to note of $1.4700:

• 61.8% of October rally
• Daily candles close above this level over 5 days
• 4-hour charts show bear trap

Daily candles vindicate support