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Quiet after a Weak Conviction Rally Raises FX Tension

Quiet after a Weak Conviction Rally Raises FX Tension

2011-10-13 16:40:00
John Kicklighter, Chief Currency Strategist
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We are in an unusual transitional phase for the broader markets. The past week has been defined by a remarkable run up in risk appetite (capital market assets, high-yield currencies, currencies that have been depressed by fundamentals); but the move has been severely lacking in participation. When we have an advance that lacks for conviction such as this one, there are one of two options: either the skeptics breakdown and join (filling out the bid) or the thin run collapses under its own weight.

The situation can fall both ways on this move. Fundamentals are still very discouraging with a dour outlook for growth, yield and the transfer of risk; but the foward-looking market often tries to get ahead of such developments. This means we need to wait for either conviction or direction to correct to its counterpart before we see a genuine trend set itself up. This sets us up for how we should be trading: smaller size (until conviction returns); shorter runs; reasonable stops; and with slightly less concern about correlations.

I was ignore these background conditions when I entered my short AUDUSD Monday. There was a good overhead resistance and fundamentals supporting the risk run were shaky; but there were still choppy. Nevertheless, I tried to put in too aggressive an objective (not putting up a first target); and I let a 120 pip profit turn into an outright loss. A lesson to bring forward.

Currently, I have two open positions. My EURCHF long is still in place as the SNB remains active in discouraging short-side speculative interest and the European crisis seems to be 'moving ahead' at a constructive pace. New from yesterday is a NZDUSD short from 0.7931. Respecting the short-term oriented markets, I am in a half size position; I will trail my stop after approximately 70 pips and the ultimate stop is 0.8030 and objective 0.7750. I'll keep a very close eye on the S&P 500 near the top of its range at 1,225 as my guide for risk and this pair.

In the meantime, there are other pairs out there that are interesting. I'm interested in USDJPY after that burst of volatility. If we can get a real driver, it suggests the market is ready to move higher. GBPUSD is sitting at a major pivot and Fib at 1.5775 waiting for risk appetite to relapse. The same is true for EURUSD; but the levels aren't as clean. Both EURJPY and GBPJPY offered good looking channel reversals; but I don't want to leverage the risk play given the choppy markets.

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