From the November 01, 2010 issue of Futures Magazine • Subscribe!

Extreme opportunities in the EUR/AUD

One of the consequences of trading forex everyday is the tendency to lose perspective and focus on the immediate price action of the currency pairs. In a sense, all day traders become "noise" traders looking for patterns that are, by their nature, temporary opportunities to gain pips. From time to time, however, shifting to a big picture perspective provides an uncommon view and helps us detect emerging set-ups that can signal big moves rather than short-term trends.

The euro and the Australian dollar have had extended moves and have moved nearly in tandem, even though the Australian economy is far outperforming the Eurozone. In 2009, Australian GDP grew by 0.9% vs. a contraction in Europe of 4%. Australian unemployment is at 5.3%, vs. 10% in Europe. The fact that the EUR/USD is moving strongly with the AUD/USD indicates that economic forces are not enough. A key driver of these valuations is fear of U.S. economic prospects. Both currencies are acting as safe-havens. When gold is added as a third asset category, we can see that all three are riding a sentiment wave against the U.S. dollar (see "Jump on a winner," below).

chart

We don’t know how long the extended upward moves of the Aussie and the euro will last, but there will be a time when it will end. The triggers that cause the end of these extended moves can’t be precisely predicted. It could be a mix of factors such as:

  1. The end of quantitative easing in the United States
  2. An economic slowdown in China
  3. A slow down in German economic growth because of a strong euro
  4. A sell-off in gold

In any case, the opportunity to catch the move down will emerge. The challenge is how to play this eventual correction?

The EUR/AUD cross-pair provides a play on the reversal of the current global patterns. The fundamentals of gold, the U.S. dollar, and China factors all flow into this pair. Just looking at the EUR/AUD monthly chart shows the extreme moves that have occurred where the EUR/AUD went from a high of 2.114 in January 2009 to a recent low of 1.364 in September 2010 (see "Can this last?," below). Upon closer analysis of the last six months, the downward spiral shows that momentum has slowed and the pair may be ready to reverse. The extreme nature of the long-term move means that even a purely short-term technical correction could create a significant move. This is a position that could result in a more than 1,000 pip move.

chart

If the euro just rallies against the Aussie to test the previous support area that was taken out at the beginning of the year, that would be a 15-handle (1,500-pip) move.

The challenge for the trader will be timing an entry. Because a cross pair is involved, the timing signals can come from movement in the euro, Aussie or dollar. Strength and weakness in the carry trade may also be a major factor with the Aussie being a popular long leg and the dollar a common short leg, along with the yen.

This also would mean taking a contrarian approach to those who believe inflation will be an inevitable outcome of the global stimulus, but there are signs Chinese growth may slow, which would harm commodities and commodity currencies like the Aussie.

Abe Cofnas is the author of "Sentiment Indicators" (Bloomberg Press). He can be reached at abecofnas@gmail.com.

About the Author
Abe Cofnas

Abe Cofnas is author of “Sentiment Indicators” and “Trading Binary Options: Strategies and Tactics” (Bloomberg Press). He is editor of binarydimensions.com newsletter and can be reached at abecofnas@gmail.com.

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