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Thursday, May 6, 2010

Euro and Market Psychology

A little update in the €uro, now that we're almost reaching our target, I think it's appropriate to make an update.

For the past 6 months, the EUR/USD has been declining relentlessly from 1.50 to around 1.28. It was such a nice move. Trendy, with not many retraces, etc.

All in all, a 2200 pip move, which I hope most of you were able to grab. Now what for the EURUSD?

Well, here's a graph updated with EW labels and my expectations to the mid-term future:

As you can see, the structure is beautifully textbook: 5 waves down, with what appears to be an extended 5th.

In terms of psychology, it is behaving just as predicted, and here EW can be of help too. Let me quote Robert Prechter in EWP and wave personalities:
Third Waves - Third waves are wonders to behold. They are strong and broad, and the trend at this point is unmistakable. Increasingly favorable fundamentals enter the picture as confidence returns.[...] Strength. Breadth. Best fundamentals. Increasing real prosperity. By the end, the underlying trend is considered up.
Fifth Waves - Fifth waves are always less dynamic than third waves in terms of breadth. They usually display slower maximum speed of price change as well, although if a fifth wave is an extension, speed of price change in the third of the fifth can exceed that of the third wave. (...) Even if a fifth wave extends, the fifth of the fifth will lack the dynamism that preceded it. During advancing fifth waves, optimism runs extremely high despite narrowing of breadth. Market performance and fundamentals improve, but not to levels of wave 3. Psychology creates overvaluation

The quotes are of course under a bullish view, so you just have to switch the adjectives to the opposite side, so instead of saying "increasingly favorable (....) as confidence returns" we would say "increasingly unfavourable as fear returns". The same for the fifth wave.

So let's take this into what happened since the high. We have the wave (3) in red which as we can see was the strongest part of the move in terms of breadth, and where fundamentals started to deteriorate, as also at that time the trend was unmistakable.

Then, it came wave (5), which is the current wave we are, although it's almost finished. Again, during 5th waves PESSIMIS runs extremely high despite narrowing of breadth. This is the time, where the public acknowledges what is going on. Fundamentals are at its' worst, and the euro is on the spotlight on the media, etc.

What has been going on since wave 5 on media? We now see inumerous economists calling for the end of the €uro, fundamentals are at its' worst with Greece pretty much in ruin. Portugal is pretty much going through the same path as well, although not as bad as Greece... yet.

Newspapers, and not only the financial ones, give notoriety to doom and gloomers and other financial talkheads at this point, everyone is now calling for the end of Europe and Greece and €uro currency, riots and manifestations in Greece, talk about ultimate pessimism...

For the past 2-3 weeks all I've been seeing on TV, and other types of media is everyone so bearish on Euro right now. Today, when reading a newspaper, 10 economists were calling for the end of the Euro. Tell me about pessimism...

I only ask: Where were the talking heads calling for the end of € when it was trading at 1.50 ? At that time, of course optimism reigned. We were as well in a fifth wave, but on the opposite side (bullish) so everyone was optimistic on the €. I saw people calling for values of 2.00 for the EUR/USD.

So what to expect now that pessimism took over pretty much everyone? It's time for the market to do the exact opposite thing.

I think, we are still missing one more down wave, as in the graph I posted, to conclude the wave structure. This may take us to the 1.25 level which is a strong support. Nevertheless, my view is the next big move will be to the upside, not the downside.

As for a target on the upside, well since it will be a corrective wave, the structure is a lot more difficult to predict, but the target box is a good figure of the target, especially the mid-line of the box around the 1.390ish area.

At the middle of wave [2] of course, fundamentals will stop deteriorating or at least will have that appearance. The Euro may lose the spotlight for a bit, when people will think the worst is now over...

Again quoting Robert Prechter on waves personalities (again this is under a bullish view so you have to switch the adjectives around... since waves 2 under a bullish view is a down wave, the adjectives are negative in here... so under a bearish view a wave 2 will have positive characteristics in terms of psychology):
 Second waves often retrace so much of wave one that most of the profits gained up to that time are eroded away. This is especially true of call option purchases, as premiums sink drastically in the environment of fear during second waves. At this point, investors are thoroughly convinced that the bear market is back to stay. Fundamental conditions often as bad as or worse than those at the previous bottom. Underlying trend considered down. Does not carry to new low.
 But once this wave [2] is over, wave [3] will begin...and at that time the downtrend will be unmistakable to anyone and the crisis will be already deep ingrained...
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