It has been a good week for EUR/USD bulls so far, who managed to lift the pair from 1.1637 to as high as 1.1860 by Wednesday. This rally has not been widely expected for two reasons. First, the euro has been declining against the U.S. dollar since it reached an intraday high of 1.2092 on September 8th. Its weakness continued until it fell to as low as 1.1554 two months later, on November 7th. And second, the slump has been developing between the parallel lines of a price channel, whose upper line was supposed to act as resistance and cause another selloff in EUR/USD. But it did not.
The chart below, sent to clients before the market opened on Monday, November 13th, clearly demonstrates why technical analysts should never rely solely on a trend line.(some marks have been removed for this article)
Trend lines and price channels work until they don’t. In EUR/USD/s case, the upper line of the price channel successfully discouraged the bulls several times until it failed to do so on Tuesday, November 14th, when it was easily breached, allowing the buyers to lift the rate to 1.1860.
Fortunately, instead of relying on a single line, we applied the Elliott Wave Principle to the chart and it changed everything. Elliott Wave analysis revealed that the structure of the entire decline from 1.2092 to 1.1554 was corrective. To be more precise, it looked like a (w)-(x)-(y) double zig-zag. According to the theory, once a correction ends, a reversal should be expected. So, instead of joining the bears near 1.1720 where the upper line of the channel was supposed to cause more weakness, or worse – near 1.1660, we thought the bulls were determined to stay, which made EURUSD a buy candidate. In addition, the wave structure of the price action helped us identify 1.1554 as an invalidation level. As long as it was intact, the odds were going to remain in the long’s favor. Less than four full trading days later, here is an updated 4-hour chart of EURUSD.
Using nothing but trend lines and channels to identify support and resistance levels is like playing basketball with one hand behind your back. You might score a few points, but there is no way to win the game. In order to take advantage of the whole technical analysis spectrum, analyzing the price action is crucial. In our opinion, applying the Elliott Wave principle is the best way to do it.