Bearish mMm Pattern Breaks The Greenback/Swissy Down

09/07/07 11:35:40 AM

by David Penn

A break below support at the 50-day EMA and a confirming close make for a lower USD/CHF.

Security: USD/CHF
Position: N/A

The thrill — and profitability — of successfully shorting a negative divergence or shooting star Japanese candlestick pattern at a market top is not to be underestimated. But the fact remains that one of the most effective ways of betting against a market is to do so when a market that has already shown weakness, fails to move higher after encountering resistance, and begins to move down.

We can see this happen in the US dollar/Swiss franc currency pair in the first half of September. This pair (USD/CHF) had rallied above the 50-day exponential moving average (EMA) in late August and managed to close at or above that level for three consecutive days. This opened up the possibility that the USD/CHF might regain the bullish momentum of the first half of August when the pair challenged the 1.2200 level.

Unfortunately for USD/CHF bulls ("Anyone? Bueller?"), the fourth day of the USD/CHF test of resistance at the 50-day EMA was the session at which the market opened at the same level as the previous day's close and closed several pips below the previous day's open. As such, a bearish engulfing candlestick line was formed.

Not only that, but the bearish engulfing candlestick line closed back below the 50-day EMA. Trader Gary Smith once said of shorting stocks that the chart should "look bad. If it made a sound, it would sound like a broken leg." For me, that kind of break takes place when a market closes below the 50-day EMA. And in the context of the bearish engulfing candlestick, the potential for further downside seemed great.

FIGURE 1: US DOLLAR/SWISS FRANC, DAILY. A number of bearish signals — from a bearish engulfing candlestick to a break below the 50-day EMA to an mMm in the MACD histogram — anticipated an opportunity to the downside in the greenback/swissy in early September.

Graphic provided by: eSignal.

There was yet another technical clue that supported the idea of lower prices for USD/CHF. Note in the lower panel in Figure 1 how the MACD histogram in early September began moving up, then reversed and moved down, forming a pattern that resembles the letters "mMm." This shorthand, borrowed from Alexander Elder (of Trading For A Living note), represents a potentially bearish pattern in the MACD histogram and can be used to spot short-term shifts in momentum. Here, the failure of the histogram to continue moving higher — and, instead, its movement lower — mirrored and confirmed the failure of the USD/CHF to continue moving higher after breaking out above the 50-day EMA.

The final ingredient is the confirming close. The market for USD/CHF signaled its next move on September 5 with the bearish engulfing, the breakdown below the 50-day EMA, and the completed mMm pattern in the MACD histogram. All that was required was a confirming close below the low of the session, September 5, when all these signals were created. That confirming close occurred on the following day, providing for a short entry at approximately 1.2005. Less than 24 hours later, as of this writing, USD/CHF is trading at 1.1870.

David Penn

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

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