Head and Shoulders Top in European Currencies

06/23/03 01:32:12 PM

by David Penn

Look out below for the euro ... and the Swiss franc, too. Both of these alternatives to the American dollar appear headed for correction.

Security: SFU3, ECU3
Position: N/A

Maybe the "tell" anticipating an end to the euro's current rally came in the form of a radio advertisement during a financial program that encouraged novice investors to buy call options on the euro currency. The authors of this advertisement promised to end the "mystery" surrounding options--as well as the likely greater mystery surrounding options on futures, given the relative inexperience of the apparent target audience. Perhaps the "tell" was more directly in the form of a near consensus that the American dollar is headed lower--the only debate being whether this continued decline will represent a net good (conventional wisdom) or net bad (various "pessimists" and the "bet against America" crowd).

But from a technical standpoint, the "tell" is in the head and shoulders top that appears to have formed in the Swiss franc--one of the many currencies around the world that has benefitted from greenback weakness over the past year and a half or so--as well as the "triple top"-like formation that has formed in the euro.

A break in this head and shoulders top could end the Swiss franc's bull market.

Graphic provided by: TradeStation.

The most recent leg up in the rally in European currencies began in April 2003 and saw the euro increase from 1.0520 (basis September) in April to a high of 1.1865 at the end of May. The euro has remained close to these highs, with its June low at a relatively lofty 1.1477 as of this writing. At the same time, the Swiss franc had been in a similarly powerful cyclical upswing, the most recent up leg of which saw the Swiss franc bounce from an intermediate low of 0.7146 (basis September) in late April to a high of 0.7842 in late May. While both the euro and Swiss franc appear to be consolidating near these highs, it is the Swiss franc whose consolidation most resembles an actual topping formation--namely, a head and shoulders top.

The developing head and shoulders top in the Swiss franc developed over a six-week period from the beginning of May to late in June. It is composed of a left shoulder in the first half of May, a head from early May to the beginning of June, and a right shoulder in the first half of June. The size of this consolidation from the late May high of 0.7842 to a neckline of 0.7570, is approximately 270 points which, when subtracted from the value at the neckline projects a downside of 0.7300.

How similar is the situation for the euro? The euro appears to have made three peaks from mid-May into June. There is also a level of support at 1.1593 where the trough lows between these peaks has formed. This alone suggests that a swing low ("swing" in Stan Weinstein's sense of the word), should the euro in fact break down, of approximately 300 points to a level around 1.1293. However, looking closely at the price action in early May, it is possible that the euro is completing a head and shoulders formation in and of itself. This head and shoulders top would be valid if the current decline in the euro finds support around 1.1337, rallies--arguably no higher than the recent support at 1.1593--and then resumes its descent. This would change the formation size from 300 points and a breakdown at 1.1593 to a formation size of almost 530 points and a breakdown at 1.1337. A head and shoulders breakdown in the latter instance could take the euro to approximately 1.0810.

A top in the euro? The retreat to the support that looms at 1.1337 could actually set up an even deeper decline in the future.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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HEAD & SHOULDERS

Head and Shoulders Top in European Currencies

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