Early last year, I was being interviewed on financial T.V about the Euro. The currency was hovering at around 1.06 versus the Dollar at the time and the interviewer was convinced it was about to go to parity. He was looking for my agreement with his view and although from a fundamental perspective, the Euro had every right to continue weakening against the dollar, that’s not actually what happened.
You see when the Euro/USD was down at those 1.06 levels, it seemed the whole market had a bearish view on it. Every major bank seemed to be short and sentiment indicators were massively skewed on the short side too.
Here lies the problem. When the majority of market participants are short, who is left to sell in order to keep pushing that market lower? Plus at this stage, it only takes a small amount of buyers to actually start turning it around. Once the Euro started bouncing, weaker hands start to cover their short exposure and that helps push the price higher once more until there becomes a stampede for the exits. The Euro flew to 1.14 in a very short time as a result of that short covering rally.
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So my point is that when you see an extreme of market participants on one side of the market, be wary that it may be close to a short term change of trend. It’s not an exact science but something that should be monitored. The Euro from a fundamental perspective, should have continued to fall, but sentiment put a halt to it. Remember, its buyers and sellers that really move the market….
Looking at the daily chart of cable, the news yesterday of Boris Johnson coming out in favour of Brexit created a 100 pip gap down over night. The pound looks like it wants to break to new lows for the year against the Dollar but just one word of caution, by some measures there’s extreme short positioning currently in this currency pair so at some stage we could see a squeeze in the next month…
Have a great week
Charlie Burton,.
Ezeetrader
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