A lesson in risk management from trading the euro

The euro is giving some terrific opportunities for spread betters, says John C Burford. But with very strong forces influencing the market both up and down, a disciplined approach to trading is essential.

In my last post, I showed how by using my simple tramline method, I could have performed some good short-term trades in the Dow Jones. And now the euro is giving us some terrific opportunities.

I have said that the euro and the Dow (and S&P) are moving in lock-step, so this is not surprising. If you watch the short-term movements on your screen - you can put up both charts on one screen if you wish - you will see this very clearly.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Why are the two markets moving in sync? Good question.

From a macro perspective, stock prices are being supported by the waves of liquidity being thrown at the US economy. These changes in liquidity are instantly reflected in stock prices. By liquidity, I mean the sum of cash and credit.

Advertisement - Article continues below

As we all know, cash is rising from the effects of quantitative easing (QE - money printing), but credit is another matter entirely.

In general, the amount of credit outstanding in the US has been falling for some time. Debts are either being wiped out (via home foreclosures), or cut (individuals paying off their debts).

It is the constant inter-play between cash and credit in the economy that is giving us the ups and downs of the stock market at least that is how I see it.

The value of the euro reflects liquidity

The value of the EUR/USD is changing mainly by the same mechanism. As cash and credit declines (falling stocks), the value of the dollar rises (investors see a more balanced economy ahead and believe the dollar is cheap).

Recently, the euro has seen a large decline from its 4 May peak at the $1.4940 level. Here is the daily chart:


(Click on the chart for a larger version)

Advertisement - Article continues below

The chart goes back a year and shows the recent lowest tramline break - and the almost inevitable pull-back.


(Click on the chart for a larger version)

Note the good tramline trio I am able to draw (if you put this up on your screen, you will find they have more good touch-points in previous trading!).

In particular, the lowest tramline has held right down to the low on 16 May. Also note the generally rising momentum readings at the various lows (green arrow), indicating a lessening of selling pressure. This is often a fore-warning of a rally ahead.

And that is what we get - my central tramline was penetrated late on 17 May. Short-term traders could set buy-stops there, looking for a rally.


(Click on the chart for a larger version)

Advertisement - Article continues below

What next?

The rally continued (but in a choppy fashion) - towards my upper tramline.

But wouldit make it? After all, the market has bounced to the Fibonacci 23.6% retrace of the big move down, which can represent big resistance.

The other big factor is that the rally off the $1.4050 low can be seen as an A-B-C pattern. Elliott wave theory clearly puts three-wave movements as corrective to the main trend (in this case, down).

This means we have two very strong technical forces fighting over this market - one pulling up, and the other pushing down.

As a result, the move out of this dilemma should be very powerful.

But a disciplined trader, having entered around the central tramline as noted above, would move their protective stops to break-even, following my break-even rule. At worst, they would come out of this trade with no loss.

Advertisement - Article continues below

Depending on what happened next,a trader who had gone long around the central tramline would either be stopped out for no loss, or could see a rally up to my upper tramline. Either way, a satisfactory position to be in.

NB: Don't miss my next trading insight. To receive all my spread betting blog posts by email, as soon as I've written them, just sign up here .




The currencies to bet on this year

The US dollar could be set to weaken this year, while the euro, Canadian dollar and the Swiss franc could be good bets for optimistic traders.
17 Jan 2020

Welcome to Currency Corner – your weekly guide to the world’s biggest market

Forex is by far and away the biggest market in the world, with an average daily trading volume of over $5trn per day. Here, Dominic Frisby looks at th…
3 May 2019

The nature of money

The best currencies are based on a strong democracy, strong institutions and a firm attachment to both the rule of law and the protection of private p…
28 Feb 2019
Spread betting

Boeing's share price plummets: here's how to play it

Boeing shares have fallen by a third this year. But there could be worse to come. Matthew Partridge explains how traders should play it
10 Feb 2020

Most Popular

Silver and other precious metals

You should all own some silver. Just don’t expect it to make you rich

Silver is cool, beautiful and immensely useful. But for investors it's the most frustrating of metals. Dominic Frisby explains why you should own some…
12 Feb 2020
UK Economy

Britain has a new chancellor – get ready for a major spending splurge

The departure of Sajid Javid as chancellor and the appointment of Rishi Sunak marks a change in the style of our politics. John Stepek explains what's…
14 Feb 2020

Money Minute Friday 14 February: The latest from RBS, Britain's state-owned bank

Today's Money Minute previews results from RBS – Britain’s state-owned bank – and from pharma giant AstraZeneca.
14 Feb 2020

Is 2020 the year for European small-cap stocks?

SPONSORED CONTENT - Ollie Beckett, manager of the TR European Growth Trust, on why he believes European small-cap stocks are performing well.
12 Feb 2019