The EUR/USD had a strong bull reversal on Thursday, but it was in the middle of its yearlong trading range. The trading range is forming lower highs and higher lows, and is therefore also a triangle. Trading ranges are built from two legged moves up and down, and the 2nd leg is often stronger than the first. It is usually a breakout that makes traders hopeful that the trading range has ended and a trend has begun.
Markets have inertia and are resistant to change, so 80% of those strong 2nd legs are traps (Second Leg Traps) and reverse. The rally was a 2nd leg up from the March 2 low and it might be a small 2nd leg bull trap. The momentum was strong enough so that at least a small 2nd leg up is likely. The minimum would be a 1-day test of Thursday’s high. It might come after tomorrow’s FOMC announcement. However, it is not necessary and the EUR/USD daily chart could simply turn down from here and form the right shoulder of a Head and Shoulders Top Bear Flag (the left should was the rally that ended on December 15).
The bulls want a breakout above the February 11 lower high because that would be a sign that the yearlong trading range might have a bull breakout. The bears want a break below the January 5 higher low. The first breakout of a triangle has a 50% chance of success, and a 50% chance of failing and reversing.
Beginners should never be upset when they look at a chart and see reasonable arguments for both the bulls and the bears. Instead, they should look at confusion as a personal radar that is detecting a trading range. In a trading range, nothing is ever clear. However, traders are confident that breakout attempts up and down fail 80% of the time. They therefore sell near the top and buy near the bottom, and take quick profits. They continue to do this until there is a strong breakout with follow-through.
Today is the 3rd day in the bull flag after the Thursday rally. The 60-minute chart is in a tight trading range, which many computers see as a triangle. The odds favor a bull breakout. The minimum goal is a test of the top of the bull breakout, which was last Thursday’s high. It is possible that there will be a Leg 1 = Leg 2 measured move up. Leg 1 last week was 400 pips tall.
Because the daily chart is in a trading range, the probabilities of everything gravitate around 50%. This means that a normally high probability buy setup, like this 60-minute bull flag, is not as high as it would be if the context was different. For example, the reversal up on December 3rd was at the bottom of a trading range and I kept saying that there was a 60% chance of a 2nd leg up, even if the trading range that followed lasted a month.
The EUR/USD has rallied for the past 4 hours in Europe, but the rally was only 50 pips tall, and it is still within the 3-day trading range. Until there is a breakout, there is no breakout. This means that bulls will be quick to take profits until there is a strong breakout above the 3-day bull flag. The odds are that this rally will soon convert into a trading range, which means that online day traders will probably look to scalp for 10 – 20 pips, and take a lot of limit order entries, like they did on Friday and yesterday.