Is last week’s bullish reversal in the euro signs of things to come or a bull trap, asks Al Brooks.
The EURUSD currency pair reversed up sharply from one tick above the bottom of the April 2017 gap. Traders should expect at least a small second leg up after the first three- to five-day pullback. That was the bottom of a gap on both the daily and weekly charts.
Last week was a big bull bar on the weekly chart (see below). It was big enough to generate confusion. Has the bear trend ended? Has a bull trend begun? Traders need more information, and therefore confusion typically leads to a trading range. Traders are not confident that any move up or down will go far. They therefore take quick profits, which results in at least a few sideways bars.
Did the two-year bear trend end?
The bulls are hoping that the February collapse was just a sell vacuum test of the major support at the 2017 gap. If the two-week rally continues next week, traders will conclude that the two big weeks down in early February was just a bear trap and an exhaustive end of the bear trend.
One problem with this scenario is that the previous week was only a small bull doji bar on the weekly chart. That typically is not a strong enough foundation to support a new bull trend. This is especially true when it follows two big bear bars. Traders therefore believe that the two-week rally is a minor reversal up.
Will the selloff reach par (1.00)?
The bears want the rally to be just another bull leg in a two-year bear channel. There have been many big rallies and each failed. The bears want a new low, which would close the 2017 gap. They also want the bear channel to fall below the 2017 low and then below par (1.00).
However, the two-week rally was strong enough to lead to at least a small second leg sideways to up. Consequently, the bears will need a micro double top. That minimizes the downside risk for at least a couple weeks.
Major trend reversals are uncommon
Trend resist change, therefore most attempts at reversing a trend fail.
A major trend reversal means the two-year bear trend becomes a bull trend. There are two things that would improve the chance of a major trend reversal. First, the two-week rally could add several additional big bull bars closing on their highs over the next few weeks. That would be a Bull Major Surprise.
Second, the rally could last for a few more weeks and then selloff again down to the low of two weeks ago. A strong reversal up from around that low would be from a double bottom.
In either scenario, if the momentum up is strong, there would be a 40% chance of a new bull trend. Anything less than a strong reversal up would lead to either a bear flag and resumption of the bear trend or a trading range.
It is important to understand that the current reversal is still minor. That means it will probably be either a bull leg in the two-year bear channel or a bull leg in what will become a trading range.
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