Sunday, May 23, 2010

Revisiting the Euro / Aussie Dollar cross

Hey, I hope you've all had relaxing weekends and are rested up because I think this week promises to have some juicy action in the markets. Its not so bold of a thing to suggest really, given that we had a 10% crash a few weeks ago in a span of minutes or the various global crises happening at the moment. There's the BP catastrophe in the Gulf, N. Korea is sinking submarines , Bangkok is in flames, the EU might dissolve; its starting to look like another credit crisis is brewing. This has created all sorts of action for traders as this volatility rapidly transfers wealth around the planet. Oil tanked while gold soared, global stock markets trended lower. So its really no surprise that there has been significant "fluctuation" in the foreign exchange as well.

Our good friend the Australian dollar (AUD, FXA) plunged as investors sought less risky US dollars because commodity producers declared they are pulling out in protest of new mining taxes. Here's an AUD weekly chart, I think it looks pretty similar to how it did about two years ago:

I mean, it doesn't really get much more bearish then this. You have AUD slice through its 50 and 200 dmas ina week. The CCI and stochastics scream "sell." And finally AUD plunges below that keep support from early last February around $0.86. The measure rule for this move targets $0.77 to $0.78 but I think it could easily go much lower in time. On this last push that just topped out AUD couldn't take out its former high from the bull market that ended in 2008. To me this establishes a long term secular bear market for the AUD, I got short AUD at the end of last week.

The euro (EUR, FXE) basically did the same thing AUD is doing right now about six months ago and we all know how that turned out. EUR has steadily declined on the EU crisis, even sending the "one currency" sliding through its 2008 low. You can clearly see the lower highs on this weekly EUR chart but I think there are signs of hope in the shorter term. Notice that while EUR clearly broke its 2008 low, it managed to rally back and finish last week well above this key level. The weekly EUR chart now has the "false break" we have all come to know and love, potentially this could get shorts to take profits while panicking dippies to get in before the pop:

On this weekly time frame there's not a whole lot to hang your hat on but I really like last week's inverted hammer candlestick, a sign of potential reversal. If you check out the FXE volume you'll see that last week's was the highest ever, far eclipsing the volume during weeks of the 2008 credit crisis. A surge in volume signals capitulation to me and so I've been slowly adding EUR. I might point out that I did correctly call the top in both AUD and EUR in this last cycle but it seems I was early on the AUD decline.

Each of these trades individually would result in significant US dollar exposure but if paired with equal size then the dollar risk is hedged out. In the Forex world this is a trivial concept, you'd just buy the EUR/AUD cross. After a quick glance, the chart for this cross effectively takes the best components of both above charts and brings them together. EUR/AUD had been in a narrow and declining channel for about two years. The RSI was steadily declining then all of a sudden last week, bam! EUR/AUD broke out closing the week at nearly the high with a 7% weekly gain, that's a huge move for a currency. The CCI and stochastics have not confirmed buy signals but seem on the verge of doing so. I could easily see this cross getting back to the 1.7 area which seems to be a sort of three year "equilibrium."

If you're not into the forex or don't have an account you can still take advantage of this trade albeit with much much less leverage. To do this trade with ETFs you can go long FXE whilst shorting FXA which is technically what the chart above is. To get leverage you could buy options (FXE calls, FXA puts) but frankly the forex market is much more liquid and enable much higher leverage. I do have to point out that I was wrong on this cross in February when I thought it was forming a bottom at it's 2007 low. That being said, if this cross really melts up I could see it going to my old target around 2.0.

Anyways, good luck out there this week. I'll try and get some new stock charts up soon. I'm generally getting pretty bearish on the market but I don't have and puts or short positions right now in stocks. The potential for a big capitulation bounce scares me but almost every index chart I look at is a sell.

Disclosure: I am long EUR/USD and short AUD/USD.

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