How the Euro Economy Compares to the U.S.A.

A quick look at international headlines will tell you that Europe suffers from economic problems too. Falling exports and lower household spending has caused the eurozone economy to shrink over the past six months, with rising fuel and food prices making consumers reluctant to open their wallets.

No one is yet declaring Europe to be in recession (at least, not openly!) but growth is not likely to be impressive with Germany, France and Italy braking sharply. In fact Germany, the EU’s largest economy and the world’s biggest exporter, contracted by 0.5% in the three months ending June 30 — this is the first time the German economy has dropped in nearly four years.

Both the Euro and British Pound currencies have been dropping against the dollar as well.

You can see from the two year chart below that this has been reflected in the performance of the Vanguard European Stock ETF (VGK), a market-cap-weighted index of approximately 600 stocks in 16 European countries.

VGK has more or less mirrored the Dow and became a losing proposition this past month. It’s nowhere near either its 50 week or 100 week moving averages and the most recent candle looks anything but bullish.

In June the European Central Bank (ECB) hiked interest rates from 4% to 4.25% but as you can see this has done nothing to halt the slide. At best there was a short pause in July before gravity took hold again.

And despite that new two-year low being set, there’s not even a volume spike to indicate that a bottom is in. (Look at how volume shot up dramatically in January to herald that the worst of the selling was over and that a rally was on its way).

All in all, this is a grim picture.

VGK Primed For a Bounce?

However, on the daily front, things look a bit better and there looks to be a short-term trading opportunity.

First of all we are seeing a volume rise over the last few days which coincides with an interesting candlestick pattern. There appears to be ‘morning star’ formation here although the most recent candle would ideally be much stronger and not another doji. Even so, this is the type of pattern you like to see when searching for price reversals.

Also there are two small gaps on this chart, one of which occurred in early August at the $62-$63 level and the other only three days before at sub-$60. Gaps always get filled sooner or later – it’s just a matter of time until it happens.

However, this chart gives us other reasons to be optimistic in the short term.

Signals Across Two Separate Indicators

Stochastic RSI is an oscillator that measures the level of RSI relative to its range over ‘n’ periods of time by using RSI as a foundation for the Stochastics formula. The result is an oscillator that fluctuates between 0 and 1 with a ‘buy zone’ at 0.2 and a ’sell zone’ at 0.8.

The purpose of this ‘indicator of an indicator’ is to ensure that valid signals are generated on a relatively frequent basis. Stochastics based on price often give too many signals and RSI often gives too few signals. (For what it’s worth, RSI stands for Relative Strength Indicator and compares the magnitude of recent gains to the magnitude of recent losses).

So Stochastic RSI tends to be a ‘goldilocks’ indicator that’s not too hot and not too cold. You can use it to determine when a security has been overbought and oversold (via the buy zone and sell zone), when a trend is set to resume (when the 0.5 centerline is crossed), and when a reversal is likely due to divergence between Stochastic RSI and the price itself.

Right now you can see that Stochastic RSI has just moved out of the buy zone, a signal that has worked well if you combined it with reversal candle patterns. (Note that there were no such patterns during the long descent in May/June until early July when a candle pattern plus an exit from the Stochastic RSI buy zone offered a short term buying opportunity).

The On Balance Volume (OBV) indicator is also looking interesting here. OBV measures positive and negative volume flow with the concept that volume precedes price. OBV adds a period’s volume when the close is up and subtracts the period’s volume when the close is down.

Right now OBV is worth noting because there is a clear divergence between the OBV low set in mid-July and its current higher low despite the new price low. This is usually an indication that the price will pop up — even if only for a short while.

If you look closely at the chart there was divergence in mid-August as well (again using the mid-July reference point) although the price rise didn’t last. In fairness, there was (again) no reversal candle pattern there and so the signal was much weaker.

What we are looking for in short-term trading opportunities is for many factors to correlate, much like a series of traffic lights all turning green at once so you can zoom home without stopping. You don’t need to get a signal from every indicator imaginable, just a few as we’re demonstrating here.

Putting It All Together

So right now we have an interesting confluence of factors telling us that VGK is likely to rise over the next few days:

1) The almost-complete morning star candlestick pattern

2) Two gaps that need to be filled at $60 and $63

3) Stochastic RSI leaving its buy zone, and

4) OBV exhibiting divergence with price

All these things are telling us that the fund is likely to make a short run-up to the $63 range where it will hit the 50 day moving average and experience resistance of some kind.

At that point you would monitor the candle patterns and indicator buy/sell signals to exit your speculative long position and consider a short (keeping in mind the highly bearish two year weekly chart we discussed at the start of this article).

VGK would need to exhibit a lot more strength before we’d feel confident calling a true turnaround for this fund – right now this is a lesson on spotting short-term counter-trend opportunities.

UK Phone Home

One of the few European companies you can easily buy in America is Vodafone, a UK-headquartered mobile telecommunications company with operations in Europe, the Middle East, Africa, the Asia Pacific, and the U.S. Vodafone currently generates $62 billion in revenue with a $127 billion market capitalization. It employs 72,000 people worldwide.

And interestingly enough, all the points we’ve discussed for VGK also apply for VOD. It has a similar candle pattern, price gaps, a Stochastic RSI value just exiting the buy zone, and divergence between OBV and the price.

So now you have two options in speculating on this short-term trading opportunity. Both VGK and VOD look likely to pop up a few dollars quite soon. Watch them and see if you can

a) call a top on the coming counter-trend rally and therefore
b) the best point to put on a short position

Good investing,

Nick Thomas
Analyst, Charts of the Week