Talking Points:
-Extreme SSI reading suggests further gains for EURUSD
-EURGBP carves bullish patterns suggesting Euro outpaces Sterling
-EURJPY sits on a 6 month support trend line suggesting trend is still higher
This week saw major fundamental news releases such as three central bank interest rate announcements plus a United States government shutdown. Despite the heavy week of fundamental releases, currencies saw little follow through in pricing and minimal change in their relative strength against one another.
Forex Strategy: Matching Strong versus Weak
| Currency | Up Arrows | Down Arrows | Change From Last Week |
|---|---|---|---|
| NZD | 6 | No Change | |
| CHF | 6 | Higher 1 ranking | |
| GBP | 4 | 3 | No Change |
| AUD | 4 | 3 | Higher 1 ranking |
| EUR | 3 | 4 | Down 1 ranking |
| JPY | 2 | 5 | Up 1 ranking |
| CAD | 2 | 5 | Down 1 ranking |
| USD | 7 | No Change |
Chart created by DailyFX EDU Robert Warensjo
Using forex analysis, we find three reasons for continued Euro strength. Therefore, we feel the best way to trade Euro strength is through a currency basket where you are trading a currency rather than a pair.
1) EURUSD Speculative Sentiment Index (SSI) Near a 2 Month Extreme
The EURUSD SSI reading currently sits around -3.5. This means there are three times as many sellers than buyers of the pair. SSI is a contrarian type of indicator which suggests further gains in the exchange rate are likely.
Two months ago, in August, the EURUSD SSI reading was almost -4.0. At that time, the EURUSD exchange rate was 1.34 so you can see how the majority of traders continue to be incorrect in trying to pick a top for the pair.
Additionally, the US Dollar continues to occupy the weakest spot in the chart above. If SSI proves correct, then the EURUSD should experience higher prices next week.
2) EURGBP Carves Bullish Patterns
The EURGBP appears to have put into place an important bottom. The pair appears to have established two different equal wave patterns that suggest a confluence of support in the .8350-.8400 zone. This strong support zone has briefly been penetrated a couple of times, but those losses would not hold.
Forex Education: 2 Equal Wave Patterns Converge Making a Bullish Opportunity
(Created using FXCM’s Marketscope 2.0 charts)
Additionally, the Relative Strength Index (RSI) is showing a sign of divergence which simply means the momentum to the downside is running out of fuel. When the RSI divergence is combined with equal wave patterns, the signals are powerful. It is possible the whole pattern equal wave pattern is likely to be retraced toward .88 at some point in time in the future.
Gains in the pair suggest the Euro would outpace the British Pound (GBP).
(To learn more about trading with the RSI, enroll for this free RSI course and receive a sample RSI strategy at the end. The course will take about 20 minutes to complete.)
3) EURJPY Sits on Top of 6 Month Support Trend Line
Though the Japanese Yen has been gaining some strength, it has not been able to break significant support levels against the Euro.
Forex Education: EURJPY at Trend Line Support
(Created using FXCM’s Marketscope 2.0 charts)
As you can see above, the EURJPY has been supported for the past six months by a trend line. Currently, prices rest near this trend line. We never know if support and resistance levels hold, but if the past 6 months offers any evidence about the future, we can expect to see this support level near 131.50 hold until it is broken.
Executing the Trade
Two weeks ago, we highlighted buying Euro strength through a basket of currencies. Unfortunately, the timing of the buy signal was off as the trade stopped out, yet the Euro has still gained strength in general. That is a good reminder for why it is important to trade in conservative amounts.
Therefore, so long as prices are firmly held above the EURJPY support line and so long as the EURGBP holds above .8330, then we can look for continued strength in the Euro. The opportunity can be traded by placing a EUR currency basket buy trade where we buy the Euro against a basket of currencies.
Last week, we focused on selling an Australian Dollar sell basket. We will keep that trade open in case the US government shut down and debt ceiling debacle deteriorate into an anxious market.
Good luck with your trading!
---Written by Jeremy Wagner, Head Trading Instructor, DailyFX Education
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