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FX Overbought/Oversold: EUR-Strength Becomes A Theme, CAD Still Weak

FX Overbought/Oversold: EUR-Strength Becomes A Theme, CAD Still Weak

2018-03-07 22:00:00
Tyler Yell, CMT, Currency Strategist
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Technical Analysis via RSI Key Takeaways:

  • EUR Remains Bid Ahead of ECB Against Many Currencies
  • CAD remains weakest among G10 + Crosses per RSI(3)
  • 20-Period MA crossover aligning with RSI(3) extremes can signal trend shifts

A famous moniker of the QE and post-global QE rally has been FOMO. FOMO stands for fear of missing out and is backed by the idea that growth and high price multiples to fundamental factors are the norm, so the only way to get a bargain is to buy an asset as soon as possible.

FOMO often shows up in the form of aggressive buying of an asset. When looked through the lens of RSI(3), as we do in the FX Overbought/Oversold Report, FOMO is seen in the tails or extremes.

Currently, the extremes in focus are the same as we’ve seen over the last two weeks. First, Canadian Dollar weakness, and a recent theme of Euro strength.

You can catch last week’s report here: FX Overbought/Oversold: Volatility & Extremes Presenting Opportunity

Since then, there’s also been a development in the options market whereas traders are paying a premium to protect against outsized Canadian Dollar losses when compared to traders unwilling to pay a premium to protect against outsized Canadian Dollar gains. This backdrop has helped USD/CAD gain (CAD weakness) 220 pips at the time of this writing or 1.73% gain on the week.

Additionally, the Canadian Dollar has a significant correlation to commodities, which finished the roughest month since August on the back of USD strength, which we’ll soon touch on here.

As a reminder, this report will look to a foundational technical indicator, called the Relative Strength Index or RSI calculated over 3-periods to derive trading insights that can help with entries into a trade.

To learn how to manage your trades better, check out our free trading guides here

Overbought FX Pairs and Individual Currencies as of March 7, 2018

FX Overbought/Oversold: EUR-Strength Becomes A Theme, CAD Still Weak

Data source: Bloomberg

Current FX Opportunities in Focus

Canadian Dollar Continues to Stand Out on the Tails of G10 Extremes

A quick look above, and you can see that the 3-top oversold pairs (EUR/USD, AUD/USD, GBP/USD) per RSI(3) all show USD strength. On the opposite side of the distribution, 4 of the top-5 strongest per RSI(3) have USD taking them higher. NOKSEK is the only non-USD currency at the extremes.

What’s important about this move is that multiple institutional positioning indicators show an aggressively short US Dollar exposure. Given the pitiful returns, many likely showed in February after the volatility heart-attack that opened the month; a key risk has surfaced. The key risk would be further USD strength leading to a capitulation of the USD short trade by institutions that could send USD aggressively higher and continue to prolong the USD extremes on the RSI(3).

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Chart Source: ProRealtime, IG UK Price Feed. Created by Tyler Yell, CMT

Could EUR FOMO Return? Keep an Eye on EUR/USD Breaking above 1.2597 Post-ECB

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Chart Source: ProRealtime, IG UK Price Feed. Created by Tyler Yell, CMT

Recently, a well-written analyst pick by our in-house Elliott Wave expert pick argued for a short-EUR/USD trade opportunity. Naturally, this would also play off a potential rebound in the US Dollar.

To see whether or not such a move is in play, traders should watch the thick support on EUR/USD at 1.2033/1.21 zone. A breakdown opens the possibility for an aggressive retracement that would likely have as a tailwind; theunwind of the institutional short position. Such an unwinding could see EUR/USD test 1.17, which is the 38.2% Fibonacci retracement of the 2017-2018 range.

Add Moving Average Breakouts To RSI(3) Analysis To Spot New Opportunities

Moving averages are genius in their simplicity. If the average price over a fixed period of time is moving higher, the buying forces are stronger than the selling forces. Recognizing a trend in play tends to be simple.

However, recognizing the first signs of a new trend or a continuation of an old trend is often less clear. One tool traders can add to their analysis is a combination of spotrelative to the 20-DMA combined with a breakout or breakdown in a currency pair.

In short, when a currency pair moves above (below) the 20-DMA, there is evidence that a strong amount of buying (selling) has shifted the short-term, and potentially the longer-term view.

Add to that crossover, an RSI(3) extreme of above 80 or below 20, and you could see forces shifting quickly to catapult a market higher.

Combining RSI(3) Breakouts With MA-Breakouts: EUR/USD Daily Chart

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Chart Source: ProRealtime, IG UK Price Feed. Created by Tyler Yell, CMT

For example, EUR/USD is showing a break above the 20-DMA alongside an RSI(3) reading of 82. Such a combination should keep traders on the watch for a continuation of the aggressive uptrend that resumed in November and marched steadily higher for an 8.67% gain through mid-February.

Looking To Add More To This Analysis? Try IG Client Sentiment

Euro May Rally Against the Dollar

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While simplicity is favored over complexity to the point of ruin, there may be a key benefit in adding sentiment analysis to your trading. Thanks to IG UK (parent of DailyFX,) you have access to the retail sentiment per actual positioning data that can help you see when traders are fighting strong trends that should possibly be bought rather than fought.

Retail Sentiment Signal on March 7: We typically take a contrarian view to crowd sentiment, and the fact traders are net-short suggests EURUSD prices may continue to rise. Traders are further net-short than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger EURUSD-bullish contrarian trading bias.

Access Real-Time Sentiment Analysis Here

Explanation of Columns Above:

The key column per this report is the RSI(3) column, which is showing the current calculation of the short-term RSI on key currency pairs. The default RSI setting is 14, which makes up nearly 3-weeks of trading data. Naturally, a 3-period RSI is much more sensitive to current moves in the market as opposed to looking over the last 14-days.

Learn more about using and trading with the Relative Strength Index here

How I Use This Data In My Trading:

Being a fan of trading in the direction of the trend has taught me over the years to look for opportunities at a favorable price to enter in the direction of the trend. When using this data, I am looking for an oversold reading in a well-defined uptrend to identify favorable buying opportunities or an overbought reading in a well-defined downtrend to identify favorable selling opportunities.

Traditionally, a reading above 70 on RSI favors an overbought reading, while a reading below 30 signals an oversold reading. It’s worth noting that reversals are rare, so you want to be as aware of a new normal or trend breakout, as you do an extreme counter-trend reading that may present you an excellent risk-adjusted trading opportunity.

New to FX trading? No worries, we created this guide just for you.

---Written by Tyler Yell, CMT

Tyler Yell is a Chartered Market Technician. Tyler provides Technical analysis that is powered by fundamental factors on key markets as well as t1rading educational resources. Read more of Tyler’s Technical reports via his bio page.

Communicate with Tyler and have your shout below by posting in the comments area. Feel free to include your market views as well.

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