The euro may surprise the bears

The fate of the euro has been getting more than its fair share of comment in recent months. And the rhetoric seems to be heating up in August.

For instance, a prominent investor stirred up a blaze of publicity recently by massively increasing his short bets – presumably against the US dollar. And the politicians are weighing in again with their dire predictions of gloom and doom if the eurozone is ‘allowed’ to break up.

As a generally contrarian trader with no dogmatic view, I have been looking for signals that could make a long trade make sense (more on that later). So, my antennae are fully extended to see whether the market has become too one-sided with the bears about to capsize the euro boat.

Reading articles especially in the blogosphere has given me cause to believe I have a trade. 

Many of these articles have become very strident – and that is a sign to me that a reversal is near.  It indicates an extreme of emotion – of bearish sentiment – that I always look for when planning a contrary trade.

Take a look at the hard data

In terms of hard data, I turn to the market – in particular, the Committment of Traders (COT) data. These figures tell me who is putting their money where their mouths are. Opinions are free and of no value unless they are backed up by hard data.

Here is the latest report as of 14 August:

Non-commercial Commercial Total Non-reportable positions
Long Short Spreads Long Short Long Short Long Short
(CONTRACTS OF EUR 125,000) OPEN INTEREST: 321,568
COMMITMENTS
43,152 180,962 3,058 -241,859 -73,974 288,069 257,994 33,499 63,574
CHANGES FROM 08/07/12 (CHANGE IN OPEN INTEREST: -675)
-3,590 2,509 65 3,418 -573 -107 2,001 -568 -2,676
PERCENT OF OPEN INTEREST FOR EACH CATEGORY OF TRADERS
13.4 56.3 1.0 75.2 23.0 89.6 80.2 10.4 19.8
NUMBER OF TRADERS IN EACH CATEGORY (TOTAL TRADERS: 193)
40 76 15 49 50 99 131

These figures are revealing.

First, the non-commercials (principally hedge funds that use much leverage in their positions) are overwhelmingly short by a stunning ratio of 4.2 to one.

Joining the party are the small traders (non-reportable positions) who are likewise bearish by a factor of two to one.

The smart money (principally banks), are taking the other side and are very bullish. Of course, many of these latter positions are genuine hedges against trade, but at least, the hedgers feel the great need to hedge. If they took a bearish view, this need would diminish.

But note the changes on the week. Hedge funds increased their net short positions when the market was fairly stable.

But with the lop-sided bearishness of the hedge funds – who often are wrong-footed at major turns – I sniff an opportunity.

What could set this market alight?

Let’s now get to the charts. Here is the daily going back several years:

EUR / USD spread betting chart

(Click on image for larger version)

It shows the huge area of support surrounding the 1.20 area (pink bar). This needs to be kept in mind when trading on the shorter time frame. Because this area has seen support before, it would take a massive effort to break it. To me, this indicates the downside is pretty limited.

Now let’s look at a close-up chart:

EUR / USD spread betting chart

(Click on image for larger version)

This chart shows the decline off the 4 May 1.50 major high with trading along my tramline pair. The lower one possesses a nice prior pivot point (PPP) and the latest dip to the 1.2040 level found support right on this tramline… So far, so good.

The recent rally is in the familiar A-B-C form, as I have shown in my 6 August post. So let’s zero in on the rally:

EUR / USD spread betting chart

(Click on image for larger version)

I have drawn in my tentative A-B-C labels and the pink bar represents overhead resistance.

But remember, these labels are tentative, and there is the possibility that the market could catch a bid and make new highs above my C wave top to make a larger A-B-C pattern.

This now becomes interesting. If this were to occur, the market could plough through the pink zone and head for the previous highs in the 1.27 region.

I reckon that there are many buy stops placed by bearish traders between my C wave high and 1.27 (and beyond).

So the key to this scenario is for the market to make it to my C wave high – we are less than 100 pips away as I write.

Last week, the market backed off to test the downside, but each low was higher than the previous low. This is potentially short-term bullish.

So what could set the market alight? Any number of possible events, from a statement from the European Central Bank to a dollar-bearish development. That’s the beauty of the markets – they are full of surprises. And the next surprise could be the one most people have discounted.

With the market so very oversold, the surprises should be to the upside.

A textbook move

Last week, I had my trade. Here is the 15-minute chart:

EUR / USD spread betting chart

(Click on image for larger version)

Since I suspected a rally was due, I entered a buy order near the green arrow as the market broke above the tramline. Following a sharp rally, the market then backed off to kiss my third tramline. This was textbook stuff.

Now the market is attempting to break above recent highs (pink bar).

Will it make it?

• If you’re a new reader, or need a reminder about some of the methods I refer to in my trades, then do have a look at my introductory videos:

The essentials of tramline trading

Advanced tramline trading

An introduction to Elliott wave theory

Advanced trading with Elliott waves

Trading with Fibonacci levels

Trading with ‘momentum’

Putting it all together

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