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Head & Shoulder Pattern Could Signal Euro Decline


The Liquidity Cycle is now suggesting that we may have a single, concentrated event that could overwhelm the combined efforts of the central banks of the world.

MINYANVILLE ORIGINAL Others have been noticing the steady decline in currencies, commodities, and stock indices caught by the Liquidity Cycle. On Friday morning, August 3, the Fed announced it was "conducting 'small-value' repurchase agreements as part of its overall program to test its operation(al) readiness." The announcement was framed as a "deminimis" action that had no significance; but, it was significant.

It was the first such repo since December 30, 2008, and the market sat up and took notice. Between the date of the repurchase agreements and the close on Thursday, the S&P 500 (SPX) rose 3.3%. The euro rose 2.43% at the same time and won a reprieve from a breakdown below its lower Head & Shoulders neckline.

On Tuesday morning, August 7, the Fed quietly announced a second repurchase agreement for $600,000 over a three-day period. Does the Fed know something we do not?

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For those not acquainted with the Head & Shoulders pattern, it is a highly recognizable reversal formation with a 93% reliability factor, which makes this pattern very popular with traders. The normal pattern contains three peaks, with the center peak (head) being higher than the right or left peaks, which are called "shoulders." In this case, there are five peaks, but the added complexity in no way reduces its reliability. (Source: Encyclopedia of Chart Patterns, by Thomas N. Bulkowski, page 290.)

In our previous article titled Euro Captured by the Liquidity Cycle, we announced a breakdown below the neckline drawn at 122.57 which "triggered" the Head & Shoulders pattern. The market behavior since then indicated instead a lower neckline at 120.42, and a higher neckline that may have stopped the rally in play at 124.20. It may be no coincidence that the 10-week moving average also played a part in adding resistance. It has spent the past two weeks testing the upper Head & Shoulders neckline and appears to have failed.

There are strong indications that the euro (EURUSD) may be losing the battle against the decline. The retracement from the upper neckline at 126.24 was 37.2%, while the retracement from the lower neckline at 120.42 was 27.7%. Whatever stimulus attempts that have been made to manage the euro's decline appear to have a diminishing effect.

The Euro STOXX 50 Index was lagging the Liquidity Cycle until it bottomed on June 4 along with the euro. It is now making a high in sync with the euro. There is no question that, as the strength of the euro wanes, so does the Euro STOXX 50 Index, but now the timing appears to be precisely the same. After topping on March 12, 20 days after the EURUSD high, it joined the Liquidity Cycle low on June 4. Although recent stimuli have managed to rally the Euro STOXX 50 Index by 19%, it remains in the lower half of its trading band and subject to decline without warning.

The weakest of all the world's stock indices is the Japanese Nikkei. The Fukushima reactor incident could not have come at a worse time as the Nikkei was attempting to overtake the prior year's high. In early 2012 another attempt was made to regain higher ground with the help of a substantial stimulus from the Bank of Japan. That rally topped on March 26, 34 days after the EURUSD top and the Nikkei joined the Liquidity Cycle low on June 4.

The central banks of the world have been waging skirmishes at Fukushima, Greece, and Spain but had only to deal with one at a time as they occurred. The Liquidity Cycle is now suggesting that we may have a single, concentrated event that could overwhelm the combined efforts of the central banks of the world. Too big to fail has now become too big to handle.

See more from Anthony M. Cherniawski at The Practical Investor and more from Janice Dorn, M.D., Ph.D. at Trading With Art and Science.
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