Chartists see euro in danger of downward slide

By Reuters
By Julie Haviv
NEW YORK, April 26 (Reuters) - The euro hasn't strayed from a tight trading range it has held for months even as global financial markets remain worried by the region's debt crisis and economic malaise, but a look at the charts suggests it is teetering on the brink of down trend.
The euro's price action since late-January has carved out "head and shoulders" pattern, one of the most powerful formations technical analysts use to forecast reversals.
Euro/dollar has not closed below $1.30 or above $1.35 since January 20. During this time the currency pair tested $1.3026 four times, putting in an firm range bottom.
"This is a very rare pattern when considering the four reaction lows that have formed," said George Davis, managing director, chief technical analyst at RBC Capital Markets in Toronto. "Quadruple bottoms are even rarer than triple bottoms."
Davis views $1.3026 as the "neckline" of the head and shoulders, or H&S, formation. H&S are a form of a reversal pattern, indicating the prior upward directional movement is coming to an end should bottoms - whether double, triple or quadruple, give way to the downside.
The repeated formation of tops and bottoms near the same price levels are generally considered among the most significant chart formations.
"The fact that this level ($1.3026) survived multiple recent pullbacks makes it all the more important," Davis said.
"This suggests if that level is breached on a daily closing basis the market reaction may be more violent."
Price peaks above the neckline form two ends, the shoulders, which sandwich the peak, or head. When a neckline, the line connecting the low point of each shoulder, is broken it predicts a price drop, whether sloping up or down.
The neckline is key as it signifies a point in which buying demand is strong. A breach of the neckline shows demand has diminished and selling pressure takes hold, forcing prices down.
Davis said a break below the neckline should send the euro to an initial target of $1.2869, the Jan. 23 intra-day low, followed by $1.2610, about where a 10-year support trendline lies.
The last head and shoulders pattern was late last year, with the neckline breaking on Dec. 28. The currency fell from its neckline of around $1.3050 to hit its "standard measured move objective" within a day, at around $1.2860, before reaching 2012 lows of around $1.2623.
The distance from the top of the head to the neckline is called the standard measured move objective in an H&S pattern.
Using this measure, MacNeil Curry, chief rates and currencies technical strategist at BofA Merrill Lynch in New York, said the euro should drop to $1.2550 after breaking the neckline, which he views more broadly between $1.3000-$1.3040.
"H&S patterns are not only one of the most used forms of technical analysis, but are also one of the most reliable in predicting prices," he said. "There is nothing favoring the euro right now, so the neckline should eventually break."
Indeed, Europe's troubles show no sign of going away, with Spain now in the spotlight after Standard & Poor's cut its credit rating by two notches.
FLOWS KEEP EURO AFLOAT
But breaking below $1.30 is no easy task.
"There is a technically significant level, but also a key psychological and flow-related level and its breach is likely to see position covering of weak euro/dollar longs," said Daniel Hwang, senior currency strategist at Forex.com in New York.
"That will exacerbate any technically driven downside from the H&S and is likely to send the currency to its 2012 lows."
There is also option-related interest around $1.30, one of the reasons the euro has stayed in its range. Options market makers, or bank desks, have been sold options with strikes at $1.30 and need to buy euros if it moves toward that level.
Technical resistance on the topside should not be forgotten, RBC's Davis said.
The first is located at $1.3270, a trendline formed from the highs from Oct. 2011 and April 2012. The second is resistance against a "minor" double top from March/April at $1.3385, followed by a Feb. high at $1.3485, he said.
"While the euro could continue to trace out this head and shoulders pattern, the weight of evidence suggests that investors should heed the downside risks that are percolating."

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