Hedge funds are short the euro – and they’re about to get a nasty surprise

With signs that the US dollar which hit my target at 100 this week is about to undergo a major correction, I will follow up on my coverage from Monday of the EUR/USD.

This is a market traded by many traders of differing styles, from long-term position holders to day traders. My swing trading style is in between these extremes, although I am not averse to taking a major long-term position if I believe a move of many cents is likely.

So do I believe such a major move is on the cards?

Start your trial of MoneyWeek today

Get unparalleled financial insight, analysis and expert opinion you can profit from.

Start your trial

Sign up for MoneyWeek’s free twice-daily newsletter.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Join more than 165,000 subscribers and keep yourself informed with latest financial news, insights and expert analysis to help you understand what really matters when it comes to your finances.

Sign up

At the time of my last article, I had a tramline trio working, and with T3 having been broken with a move to the 1.06 level (a major target), the usual rally up to the underside of T3 was in progress. Lurking in the background was the large momentum divergence into the 1.06 low which could support a more substantial rally:

That decline to 1.06 could have been the end of my fifth wave, so I needed to see more evidence for this call.

Yesterday, I got it. It became clear that the decline off the Thursday high at 1.0760 was a clear five down complete with a momentum divergence at the low.

That was what I was looking for, because it provided a vital clue that the final low was likely to be the bottom, and I can expect at least a partial recovery of the move down in (hopefully) a three-wave A-B-C:

If this forecast is correct, when wave C ends (probably in my pink zone around 1.0680), the decline will resume, taking the market into new lows below 1.06.

But a more bullish forecast and an equally valid one is that this could actually be a five up with the C wave also wave 1, a dip in wave 2 and then a huge rally in wave 3 to well above the 1.0760 level.

Which scenario plays out will depend on market action over the next few days.

The market is this week trying to push through T3 with three attempts so far (red arrows) and the large positive momentum divergence certainly could support such a break.

With the market on the verge of pushing up past T3, it is approaching my line in the sand. Naturally, a clear break up past that should set fire to the market. And that would be a great place to enter a trade:

If my bullish scenario is correct, what are my forecasts for price levels?

This is the huge wave down from the October high at 1.15:

That was a terrific move in about six weeks only. But if my bullish scenario plays out, my targets are the Fibonacci levels shown with the first at the 1.08 level.

On Monday I showed the latest Commitments of Traders futures data where the hedge funds had massively added to their short bets after Draghi pledged to 'do whatever it takes' to weaken the euro and get inflation out of the current negative state.

Will the heavily short market get a surprise for Christmas?