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Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

David Rodriguez, Head of Product

-Retail FX traders are their most net-short EURUSD on record

-Our retail forex sentiment-based Momentum2 system strategy is long from $1.3649

- A contrarian view of crowd sentiment favors further gains

Retail forex traders have literally never been more net-short the Euro versus the US Dollar, and a contrarian view of crowd sentiment leaves us steadily in favor of further EURUSD gains. But what are the risks?

Forex Trading Crowds at their Most Net-Short Euro on Record

forex_forecast_euro_to_dollar_likely_to_appreciate_body_Picture_5.png, Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

Source: FXCM Execution Desk Data

Our proprietary retail sentiment data shows that there are nearly 5 open orders short for every one that is long (a Speculative Sentiment Index ratio of -4.8). We saw a very similar sentiment extreme through late October when the Euro traded towards multi-year highs of $1.3830.

Yet this time around we’re seeing a slightly different dynamic: total long positions are actually at their lowest levels in nearly three years. Why does that matter? Put simply, there’s less aggressive selling this time around and more passive profit-taking. It suggests that the EURUSD could head higher as very few believe it can hit further highs. What are the technical risks?

Euro Trading Near Critical Technical Resistance at Fibonacci Levels and Mutli-Year Highs

forex_forecast_euro_to_dollar_likely_to_appreciate_body_Picture_6.png, Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

One critical risk to the Euro rally is simple: the pair is coming up on significant technical resistance. The $1.3840 level represents the 61.8% Fibonacci retracement of the $1.4940-$1.2060 decline and likewise coincides with the multi-year peak.

Resistance doesn’t always hold, and it’s certainly possible that the pair presses to fresh highs. Yet technical risks are clear, and we would trade cautiously here given the risk of failure at key levels.

We noted yesterday one other factor that may be helping the Euro at these levels: forex seasonal trends tend to produce EURUSD gains into the end of the year.

forex_forecast_euro_to_dollar_likely_to_appreciate_body_Picture_7.png, Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

Chart source: R. Forex Seasonality Studies for the month of December

The difficulty in using seasonality in trading is clear: how do you time and manage a position when all you know is that the Euro tends to rally in a given period? It’s more important to line up any such studies with other trade techniques to make it useful.

To that end we’ll continue to watch retail forex sentiment and our trading strategies for worthwhile trade opportunities in the high-flying Euro/US Dollar.

Follow any updates on the Euro and other currencies via this author’s e-mail distribution list.

Forex Correlations Summary

View forex correlations to the S&P 500, S&P Volatility Index (VIX), Crude Oil Futures prices, US 2-Year Treasury Yields, and Spot Gold prices.

forex_forecast_euro_to_dollar_likely_to_appreciate_body_Picture_8.png, Forex Crowds Are Extremely Short Euro - Why Might it Rally Further?

Data source: Bloomberg. Chart source: R SEE GUIDE ON READING THE ABOVE CHART

--- Written by David Rodriguez, Quantitative Strategist for David specializes in automated trading strategies. Find out more about our automated sentiment-based strategies on DailyFX PLUS.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.