Technical analysis involves the use of price and chart patterns to predict the movement of currencies over various time horizons, usually for profit. This is often combined with fundamental analysis, since currencies reflect underlying macroeconomic variables and monetary policy. However, regardless of the approach chosen by traders, I believe that there is a key set of trading tools that will often provide high-paying trades during both normal and heightened periods of volatility.
Using the Financial Crisis of 2008 and key events in 2011 related to the European Debt crisis, the following examples reveal the trading opportunities that appeared using these high-probability technical tools. Although some trades contradicted the expected reaction of investors to the underlying crisis, the signals still predicted the right direction in which to trade. Therefore, in the event of another period of heightened volatility, using these tools can provide attractive trades regardless of the nature or interpretation of the crisis itself.
- These identify the current trend. Breaks of these usually represent the start of reversals.
COUNTER TREND LINES
- These identify retracements against the main trend. Breaks of these usually signal the resumption of the main trend.
- Support and resistance boundaries within which price oscillates.
- Indicate the start of a new or continuation of an existing trend.
- Signal the next movement within or against the trend.
FIBONACCI PRICE EXTENSIONS
- Profit points signalled by ABC waves.
- For the pairs analyzed here, Weekly Ranges average 400 pips and Monthly Ranges 1,000 pips.
FINANCIAL CRISIS OF 2008
The financial crisis that led to the current period of economic stagnation across the world, emanated from the high rates of default in the sub-prime mortgage market in the United States and the subsequent collapse of banking and investment companies around the world. While some assets lost value precipitously as investors hastily sought to protect their capital, the Forex provided the opportunity to benefit from this period of risk-aversion. Although investors would normally sell the currency of the country that is at the heart of a crisis, shorting the EURO USD and the AUD USD turned out to be the better, more profitable choice.
The EURO USD was in a period consolidation between March and July, 2008 (see Figure 1). On their own, patterns of consolidation indicate periods of uncertainty pertaining to an important economic or financial issue. Given the period within which this particular consolidation was formed, it reflected the uncertainty surrounding the problems that were gradually unfolding in the financial world.
FIGURE 1- WEEKLY CHART CONSOLIDATION - EURO USD
Once consolidation patterns are broken, they normally provide clarity about the issue at hand, giving traders a very profitable money making opportunity. This break occurred during the first week of August 2008, leading to a lengthy movement short in which the EURO USD declined by nearly 3000 pips in 3 months (see Figure 2). This coincided with the start of safe-haven buying of the US dollar by investors.
FIGURE 2 - WEEKLY CHART - EURO USD
Within this period of heightened volatility, traders were presented with an opportunity to trade the downtrend by focusing exclusively on the technical signals provided by the Daily Chart.
EURO USD TRADE
In this trade, the Daily Chart broke the support of the large range on the 7th of August, 2008 at 1.5300. With a Stop Loss placement above the breakout candle at around 1.5500 and a take profit target near 1.4000, the trade offered a gain of more than 1,000 pips within a month (see Figure 3).
FIGURE 3 – EURO USD TRADE
When consolidation patterns such as these are broken, traders tend to aim for a price near the `Breakout Equivalent`- the distance equivalent to the width of the consolidation. In this case, take profit price targets near 1.4000 would have been good choices, with conformation coming in the form of the Tweezer Bottom on the Weekly Chart- a strong indication that the downtrend would either end or retrace temporarily before resuming the trend (see Figure 4).
FIGURE 4– WEEKLY CHART EURO USD
Turning to the AUD USD, we see from the Daily Chart that this pair was in a Pennant consolidation pattern within which it oscillated between May and July, 2008. After a very brief rally, the pair broke back inside the Pennant on its way to breaking the support and uptrend line to start a downtrend.
FIGURE 5- FALSE BREAKOUT OF PENNANT - AUD USD
The ABC signal that appeared prior to the turn back inside of the Pennant, is normally an indication that the currency pair would not only reverse, but also breakout at the other end of the consolidation very quickly. This reversal led to a decline of over 3,000 pips from 0.9600 on July 23, 2008 to 0.6000 in September, 2008. If a trader had entered selling this pair at that price of 0.9600 upon the completion of the ABC signal, a take profit target near the Breakout Equivalent would have yielded a 1,000 pip gain by August 12 – more than enough compensation for losses incurred going long initially.
THE EUROPEAN DEBT CRISIS
During the current year in which the threat of a major crisis and financial market contagion loom large over Europe, technical signals led the way in providing trades for several EURO crosses. Using the EURO USD and the EURO CHF as examples, we can look at what took place during March and April when Portugal, Greece and Ireland received their respective downgrades.
On April 11, the EURO CHF began a downtrend within a consolidation pattern that was signalled by a break of its uptrend line (see Figure 6). This movement against the EURO towards the relative safety of the Swiss Franc was a natural response to the downgrade of Portugal’s debt by Fitch Ratings and Moody’s just a few days earlier.
FIGURE 6- EURO CHF DAILY CHART
Using the Daily Chart itself or a lower time frame, an entry close to 1,3070 and an exit price near 1,2800 at the start of the small range, would have yielded close to 300 pips for the weekly range trader. In contrast to this, the EURO USD continued to provide long position trades that did not appear to be in sync with the expected reaction to events unfolding in Europe.
From the chart below, we see that there were two opportunities to trade this pair within the major uptrend. With the breaks of two Counter Trend Lines (CTL) seen here in Figure 7, the weekly range trader would have been able to capture some of the 300 pip rally from 1.4250 to 1.4547 and close to a 400 pip profit over a nine day period in the second trade.
FIGURE 7 – EURO USD DAILY CHART
As we saw from the preceding examples, technical trading signals that are in sync with the natural dynamic of the Forex market can be used successfully to trade currencies during major financial crises. Although some of the trades provided by the charts appeared counter-intuitive in relation to the nature of the crisis, it is always better to follow the major signals provided by the charts to ensure continued profitability.