Currency markets have a habit of moving beyond our best (or worst) expectations, despite our best efforts at pinpointing trend changes. Who would have guessed last year that the US dollar would zoom higher to appreciate by over 20% in just a few months to reach the 100 print?
The EUR/USD moved from 1.40 in May last year to the recent low at 1.05 – a decline of 25% – in a relentless liquidation of long positions by the army of dollar bears. But in May at the dollar low, it was doomed according to received wisdom.
Clearly, the vast majority were ultra-bearish the dollar last year – as shown in the sentiment data I showed throughout the year – which of course was a necessary condition for a solid bull market to get under way.
And even in the short-term – the timeframe that swing traders operate in – swings can exceed expectations, and this was vividly illustrated earlier this month.
Bears outnumbered bulls 33-1 – my rally was highly likely
In my last post on the euro on 8 April (“The euro’s hitting powerful resistance, but I think a big rally could be on the cards”), I showed my best guess of the likely short-term path for EUR/USD. The powerful resistance was shown by the pink bar where the three previous rallies had stalled. I was looking for a strong third wave rally which would break that resistance.
I had my “line in the sand” as a warning that, if the market broke below that level, my proposed rally would be in jeopardy, not necessarily dead in the water, but certainly delayed.
Remember, I am working from a bullish stance that I explained in my Trader post of 13 March, the very day of the 1.0460 low. This is what I wrote then: “Remember, bear markets always terminate when bearish sentiment is elevated, which it clearly is at present. In fact, the latest DSI (Daily Sentiment Index) showed a 97% bullish dollar reading this week!”
So, with euro bulls being outnumbered by about 33-to-one by the bears, the path was clear for a significant turn.
But just because sentiment was heavily skewed, it doesn’t give us licence to jump in with both feet. That is not a reliable winning strategy. Remember, sentiment is not a precise timing tool. I use it in conjunction with my tramline methods, which are precise timing tools.
Perfect trading signals let you forget dogma and focus on the short term
I have seen some markets just keep on going way beyond where I believed they ‘should’ be even with sentiment having reached extreme levels. In fact, today’s stock and bond markets are prime examples of this phenomenon.
In my post of 23 March, I showed how you can use these precise tramline tools to position yourself in the correct direction and at low risk. On my hourly chart I noted the positive-momentum divergence at the 13 March low and on the immediate rally, I could draw in a nice green trendline across the tops. A buy stop placed just above this green line was the textbook trade. The kiss back to this line on 19 March was another perfect signal.
The key point is that these are traditionally-high probability trade setups and, with protective stops placed just below the green line, two very low risk trades were available. A swing trader can ask for no more.
Just a few of these per quarter-year will allow you to thrive as a trader, provided you also manage your trades well (see later).
One further point: when trading in this manner, you do not have the burden of having to decide whether you are bullish or bearish the euro. You simply follow the sentiment data and your analysis of the charts.
Many traders seem to have a dogmatic view of the markets. If you read comments sections of some blogs – I only do it occasionally for entertainment purposes – you will see that many who post comments have a visceral hatred of the eurozone. And they translate that into a belief that the euro is doomed as a currency.
The current crisis events in Greece do nothing to dissuade them, of course. If they do trade, they are destined to fail because they will not see what the market is telling them.
I had to be patient, but I got my rally
So, was my line in the sand violated? It certainly was! As the market broke below my A wave low, I still kept an eye out for a possible turnaround of my C wave, so long as the all-time low at 1.0460 was not violated. Then, on 14 April, I got my buy signal with a nice positive-momentum divergence and break of short-term (green) trendline.
The strong rally soon after told me I was very likely on the right track – and a bigger rally was on the cards.
In swing trading, the management of your trades is critical for your success. You’ve got into a low risk trade and it is going well. How do you manage it?
One disciplined way is to use my split-bet strategy where you take partial profits at certain milestones. And that is what I did on Friday when the market made a hit on the Fibonacci 62% retrace of the previous wave:
I was long from last Tuesday at the 1.0580 level and exited partially at the 1.0820 level for a very tidy profit of 240 pips in four days. Meanwhile, I have kept the remaining part of my original position and have moved my protective stop to break even.
Even if the euro collapses from here, I am guaranteed a 240-pip profit overall. And if the market does not touch off my stop, I am destined for even bigger profits.
That is a low-stress position for any trader to be in.