I’ve made big profits going long the euro

In my post on 1 May (“Forget the doom and gloom, the euro’s on the up”), I predicted a euro rally. Sure enough, the EUR/USD cross has rallied from 1.12 at the beginning of May to the current 1.1450 area.

I want to examine whether the market has done enough to correct the excessive bearish euro sentiment that prevailed at the 1.0460 low on 13 March. Such a correction is necessary before the euro can decline again.

After all, that sentiment extreme in March was one of the pieces in the puzzle that provided me with a contrarian bullish outlook back in March. So, as bullish sentiment is getting up off the floor, the market has followed.

Today, I will look at the wave pattern together with current sentiment readings to check on the potential for further gains, or whether the market is poised to drop.

The ‘experts’ were scratching their heads, but I was confident

The euro has maintained its upward trend in recent days, despite the ongoing Greek debt crisis. So what was the driver of this strength? Pundits were almost universally surprised that the euro looked strong.

So despite all of the negativity, the euro has managed to recover. Do you not find that strange? You shouldn’t, if you follow the inputs that I do!

In my trading career, I have found that when the ‘experts’ are bamboozled, I am usually on the right track. I use this as a kind of contrary indicator.

In my latest euro post on 8 May, I had this chart showing the exit from my long trade which gave a profit of 700 pips:

EUR/USD spread betting chart

However, that is not the end of the story! Because I was using my split-bet strategy, I only unloaded one half of my position there. I still carried the other half open – and raised my stop to just under the wave 4 low.

That allowed me the possibility of making further profits if the market decided to disobey my tentative Elliott-wave labels and push on further. That is one of the advantages of using this strategy.

The updated hourly chart shows the market had not finished its rally. But with momentum waning, I judged that was a great place to exit my remaining long position at the 1.1430 area for a great profit of 800 pips to add to the 700-pip gain.

EUR/USD spread betting chart

Total profit = 1,500 pips from my initial entry in mid-April.

That rally gave me a big profit, but what’s next?

The euro rally gave me a very healthy profit indeed. But the market may be gearing up for even bigger gains, so let’s try and assess the odds.

On the daily chart below I’ve shown the original pair of tramlines I was working with. My first upside target on T3 was hit on the rally. But after the expected bounce down off the T3 resistance, the market girded its loins and rallied hard last week to close above T3, albeit on a weakening momentum (matching that on the hourly chart).

EUR/USD spread betting chart

But note my Elliott wave labels. I have the March low as my wave 3 and we are currently in the wave 4 rally, which is looking very much like an almost-textbook A-B-C affair.

If I am correct, we are in the final stages of the C wave and wave 4. And the hourly chart shows a nearly-completed five up (see top chart). Momentum is sputtering, and is confirming this picture.

Trader sentiment suggests a big euro turn

Now what does the sentiment situation look like here?

Because markets move up and down according to changes in sentiment, then I would expect that dollar bullishness would now be very low. In fact, latest DSI (Daily Sentiment Index) shows dollar bullishness in single figures – a sharp turnaround from the exact opposite situation in March.

So, when the dollar was over-loved in March, the market turned. Today, with the exact opposite situation, will the euro make a major turn?

Here is latest COT (commitments of traders) data:

Non-commercial Commercial Total Non-reportable positions
long short spreads long short long short long short
(Contracts of EUR 125,000) Open interest: 439,122
43,333 222,309 8,386 345,101 127,933 396,820 358,628 42,302 80,494
Changes from 05/05/15 (Change in open interest: -10,132)
-6,783 -17,934 -1,387 1,120 11,863 -7,050 -7,458 -3,082 -2,674
Percent of open in terest for each category of traders
9.9 50.6 1.9 78.6 29.1 90.4 81.7 9.6 18.3
Number of traders in each category (Total traders: 233)
53 90 32 52 60 122 166

The hedge funds (non-commercials) are overwhelmingly short the euro by a factor of more than five to one, confirming the DSI readings. The small retail traders (non-reportables) are likewise bearish the euro but ‘only’ by a factor of two to one.

However, note that the hedgies lifted a large number of shorts that week in what I term a short squeeze. That was what I was looking for in March.

Is the euro ready to begin another descent, and possibly take out the March low? This evidence certainly seems to point that way…