How to find the path of least resistance for EUR/USD

A belief that "news makes the markets" would have lost you a lot of money betting against the euro, says John C Burford. Here's what to watch instead.

Later today, it is the turn of the US Federal Reserve to announce its intentions regarding the Fed funds interest rate (and possibly more quantitative easing later?). This should affect EUR/USD.

I have a question for you. If you were handed in advance the text of what Mario Draghi or Janet Yellen were about to say in their monthly reports, regarding their plans on changes in interest rates and money-printing (as many are, I believe), which way would you trade ahead of the reports?

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

Goodness knows, so many pundits obsess about these events before the event and then pore over the entrails afterwards. You would think that they contain the key to unlock riches beyond compare.

This has to be the supreme test of the near-universal theory that the news (and economic data) makes the markets. Surely, only a rabid contrarian could believe that increasing the supply of a currency could strengthen it. Or lowering interest rates into even deeper negative territory would also strengthen it.

Advertisement
Advertisement - Article continues below

And if it turns out that you have guessed incorrectly, would you abandon that theory?

Well get ready to do just that. This is the EUR/USD performance after the December European Central Bank (ECB) announcement where Draghi shocked the markets by not only going negative on rates for the first time, but also kicking off a mammoth bond-buying spree. I call this his Big Bazooka Mark 1:

160316-MWT-01

Ouch! It seems that he aimed his bazooka on his own army in a display of friendly fire! That was an eight cent appreciation on D-Day 1 in the "wrong" direction.

And here is last week's carbon copy performance when he ramped up the money printing and went even more negative on rates:

160316-MWT-02

This time, the collateral damage was worth four cents to the enemy from that wrong-way Bazooka Mark 2. And the economic damage, under conventional thinking, is to future exports from the EU, which is the opposite of stated intentions. Another example of unintended consequences from one of the omnipotent central bank coterie!

Twice, the conventional and entirely rational conclusion must be that having prior knowledge of the ECB's intentions in December and this month caused a "sensible" trader to lose money.

Advertisement
Advertisement - Article continues below

Of course, this perverse behaviour can be rationalised by invoking the "sell the rumour, buy the news" principle (STRBTN), as I did. But that has nothing to do with the "news makes the markets" theory. It is only in hindsight that you can label the move as a STRBTN. Sometimes it works and sometimes it doesn't.

The rational conclusion must be that by correctly placing the horse before the cart, it is the news that makes the market. And that means that most of the material a typical investor reads is misleading (or worse), especially when it appears in the mainstream media.

But I still read it! It is in the understanding that in the interests of research, I am attempting to judge market sentiment. And sentiment was bearish the euro going into both D-Days, making the market vulnerable to short covering, no matter what Draghi had said.

These two events are examples of how, by taking a reading on sentiment, you can be in touch with the most likely path of least resistance. When you can do that, you can locate high probability/low risk trades, which are the only type of trade I consider. I must feel I have the odds very much on my side before I commit funds.

That means I rarely "chase" the market after a sharp move. Buying in a rapidly rising market is often hazardous because sharp snap-backs could occur at any time and stop you out.

A great example of this is provided by the above charts. If you were a little late in the day, you might be tempted into going long EUR/USD after the rallies had tipped its hand. But that was the most dangerous time to do that going long on December 3 around the 1.10 area was high risk because the market settled lower after your entry in a normal consolidation.

Advertisement
Advertisement - Article continues below

In general, I like to enter trades as the market is emerging from a congestion zone. Here is my trade entry on D-Day 1 in December:

160316-MWT-03

In anticipation of a possible sharp rally, I had placed my entry buy-stop just above my blue trendline, which was hit as the market exploded upwards. This entry was still inside the congestion zone the market had formed since November.

The point is that in these zones, there are many "wrong" way short bets that must be unwound as the rally gets under way. This acts like a line of dominos falling over and at no time is a long trade at risk. That is the ideal swing trade entry.

Today, we shall learn what the Fed will (or won't) be intending. Is there a currency trade here?

Advertisement

Recommended

Visit/currencies/600640/the-currencies-to-bet-on-this-year
Currencies

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
Visit/506272/welcome-to-currency-corner-your-weekly-guide-to-the-worlds-biggest-market
Currencies

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
Visit/502761/the-nature-of-money
Currencies

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
Visit/trading/spread-betting/600782/boeings-share-price-plummets-heres-how-to-play-it
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

Visit/economy/inflation/600799/federal-reserve-inflation-money-printing
Inflation

Here’s why the Federal Reserve might print more money before 2020 is out

The Federal Reserve wants to allow US inflation to run “hot” for a while. But that’s just an excuse to keep interest rates low – and possibly print mo…
10 Feb 2020
Visit/investments/investment-strategy/600804/the-secret-to-avoiding-being-panicked-out-of-your-portfolio
Investment strategy

The secret to avoiding being panicked out of your portfolio

With the coronavirus continuing to occupy headlines, investors still aren’t sure how to react. But the one thing you mustn’t do is panic. Tim Price ex…
11 Feb 2020
Visit/investments/investment-strategy/600772/just-five-assets-matter-for-investors-portfolio-asset-allocation
Investment strategy

Just five assets matter for investors. Here's what they are

Every investor’s needs are different – but most can be met by the right combination of five investments
11 Feb 2020
Visit/investments/commodities/600729/the-rare-earth-metal-that-wont-be-a-secret-for-long
Sponsored

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020