The euro rallies ahead of interest rate decision – what next?

I will cover the euro today since we are on the eve of the much-awaited announcement from the European Central Bank (ECB) – will they or won’t they? I am talking of the rumours that they will lower the benchmark interest rate, currently at 0.75%, which has held since July 2012.

The conventional thinking is that if a central bank lowers rates, it will put pressure on the currency.

But as I have explained in recent posts, markets often pay no heed to convention.

This means that we sometimes experience the ‘sell the rumour, buy the news’ effect. In other words, the market will immediately move counter to what’s expected.

When I say ‘expected’, I mean what the conventional thinkers expect – mainstream media, most ‘experts’, and so forth.

Unconventional traders will find reasons – within their trading methods, of course – to think the unthinkable. History tells us that is where the money usually lies.

When I last covered the euro on 22 April, I noted that the market was drifting lower and I wrote: “OK, so the market is telling us that it wants to move lower – perhaps to my lower tramline just above the 1.30 area.

“Short-term traders will be eyeing this level to take at least partial profits.”

This was the chart back then:

Euro/US dollar spread betting chart

(Click on the chart for a larger version)

So the 1.30 area was my target, and this is how it played out:

EUR/USD spread betting chart

(Click on the chart for a larger version)

My target was hit (red arrow) – and after several tramlines had been drawn.

But thereafter, the market found support and on Thursday 25 April, the decline off the 17 April high was looking suspiciously like an A-B-C – complete with a positive-momentum divergence.

 

Time to look for a long trade.

EUR/USD spread betting chart

(Click on the chart for a larger version)

Because I was looking for a long trade, I needed some down-sloping tramlines – and these are the tramlines I found on 25 April.

The upper one has all of the high touch-points, and the centre line also is pretty good.

I then waited for a break up through the upper line, and early on Thursday, I had my break. That was my long entry in the 1.3040 area (red arrow).

Trader tip: With tramlines, you have a natural place to enter the market and can place stop orders ahead of time. You really do not need to keep watching your screen – and going cross-eyed! Simply check every so often and if your order is filled, get your stops in pronto.

I decided to give this trade a little room and placed my protective stop just under the 1.30 level.

To me, if the market could rally to the previous minor high at 1.3080, there should be enough shorts with their stops anxious to escape.

As I write this morning, these shorts have indeed been squeezed:

EUR/USD spread betting chart

(Click on the chart for a larger version)

The market moved up sharply, and I could then draw in my new tramlines, as shown.

To cap it off, the market came back to kiss the centre tramline (blue arrow) – and took off in a scalded-cat bounce.

That is classic trending behaviour, as I have shown many times in previous posts.

I always look for these kisses as it gives me increased confidence in my trading stance.

Of course, if you had missed the earlier entry, this was also a great low-risk place to enter a long trade.

And now the market has reached the upper tramline target just under the 1.32 level (red arrow) – and I can move my stop to break-even.

Now, the next target is the previous major high at 1.32 set on 16 April.

I imagine that there are plenty of buy stops sitting right there.

Remember, I had a potential 1.3350 target from last time. Is it possible it will be hit sometime soon?

Let’s see how the commitments of traders (COT) data looks to take a sentiment reading:

Non-commercial Commercial Total Non-reportable positions
Long Short Spreads Long Short Long Short Long Short
OPEN INTEREST: 220,051
COMMITMENTS
47,807 82,082 5,603 127,780 78,147 181,190 165,832 38,861 54,219
CHANGES FROM 04/16/13 (CHANGE IN OPEN INTEREST: 4,394)
-1,514 2,997 -155 6,408 1,289 4,739 4,131 -345 263
PERCENT OF OPEN INTEREST FOR EACH CATEGORY OF TRADERS
21.7 37.3 2.5 58.1 35.5 82.3 75.4 17.7 24.6
NUMBER OF TRADERS IN EACH CATEGORY (TOTAL TRADERS: 175)
34 67 26 46 44 95 122

As of 23 April, the hedgies remain overwhelmingly short, as do the small traders.

And during that week, the large specs shifted to an even greater short position. Remember, this was just as the market was testing the 1.30 level and just prior to the big rally.

This means, I can deduce that the rally to the current sub-1.32 level was propelled in part by a big squeeze on these specs.

I like that!

But whatever the outcome of tomorrow’s ECB announcement, I have a no-loss trade working, and I will even reap big rewards if my 1.3350 target is approached.

• 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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