FX Overbought/Oversold: Commodity FX Overbought Amidst Broad Downtrend
Technical Analysis via RSI Key Takeaways:
- Sterling strength pervasive, favoring further broad upside
- Canadian Dollar catches further break on BoC survey further projecting strength
- US Dollar only strong against EMFX on China Yuan devaluation speculation
A broad look at markets can be helpful to see where patterns and themes are developing. Looking at the Relative Strength Index or RSI calculated over 3-periods can help traders to derive trading insights that can help with entries into a trade or where their attention should be focused.
Currently, British sterling strength is becoming a theme worth traders attention. When strength is predominant, there are typically two plays for traders to utilize the information.
First, looking for opportunities GBP against weaker currencies like we see with the Australian Dollar. Second, think twice or three times before selling such a strong currency. In my experience, traders biggest frustration comes with a short position put on too early. In other words, the story driving the strength of the currency they’re selling has not broken yet and the strength remains.
Currently, that appears to be the case for the British Pound (GBP) as well as the Canadian Dollar.
On the weak side, the picture is not as clear except for weakness surrounding the Australian Dollar, which I’ll outline in a moment. The US Dollar, which is in the cross-hairs of the trade dispute between the US and China looks susceptible to further losses, and the potential for a weakening Chinese Yuan (CNH) looks to be spreading weakness to other emerging market currencies as well.
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Overbought FX Pairs and Individual Currencies as of April 9, 2018
Data source: Bloomberg
Current FX Opportunities in Focus
A quick look above, and you can see that the 3-top overbought pairs (USD/ZAR, GBP/CHF, and GBP/JPY) per RSI(3) show EMFX weakness on behalf of USD/ZAR and Sterling strength that is best expressed through selling heave currencies like CHF and JPY. Typically, a weak JPY or CHF is a sign that risk sentiment is doing well, and the rise in global indices backs that view up as of Monday.
On the opposite side of the distribution, 2 of the top-3 weakest pairs per RSI(3) have show EUR currency weakness alongside the Australian Dollar.
GBP Strength – Difficult to chase absent concrete Brexit breakthroughs/ BoE hawkishness
Over the last year, the theme that most traders have realized despite implications was that developments like elections that were seen as certain to derail global markets have had the opposite effect.
While it’s too early to say specifically what will happen to the Brexit outcome, it’s fair to say that while tail risks remain, there are also reasons to be optimistic on a positive outcome. At least, that appears to be the market’s take as GBP strength has recently dominated the G10FX headlines and the Bank of England remains in focus via the SONIA curve to see if overnight index swaps will start to price in a steeper rate path on near-term rates.
As the risk premium around Brexit erodes, it’s fair for traders to continue to look for G10FX weak links to sell against Sterling. One currency that continues to fail to be a resumption of new buying is the US Dollar.
Short-term support on GBP/USD sits near 1.4000 with spot ~130 pips higher. Broader pattern support on the persistence uptrend sits at 1.3650/3750.
The bullish swing target is at the 2018 high of 1.4350 with a broad weakening of USD or strengthening of sterling potentially bringing the pair closer to 1.5000, a level we have not seen since the Brexit vote of June 2015.
Chart Source: ProRealtime, IG UK Price Feed. Created by Tyler Yell, CMT
AUD weakness a theme of potential trade war collateral damage hitting AU
Recently, markets heard from RBA Governor Philip Lowe, who looked comfortable with the record low-interest rate remaining at the 1.5% floor for the foreseeable future. The dovish tone has been complemented by economic data. The Citi Economic Surprise Index for Australia has been on a steady decline for 2018. While the index is mean reverting, it does show that Australia remains susceptible to collateral trade damage from the negotiations between the US & China.
Of course, traders need to know what is strong or where the misbalance lies in the markets to play the opportunities. Surprisingly, not all commodity currencies have been weak of late, and the Canadian Dollar looks to be an opportune currency to buy against the Australian Dollar.
Chart Source: ProRealtime, IG UK Price Feed. Created by Tyler Yell, CMT
As mentioned above regarding the erosion of the worst case scenario surrounding Brexit, a similar development is being applied to the Canadian Economy with the NAFTA renegotiations. The erosion of risk premium has lifted the Canadian Dollar and a recent business outlook survey from the Bank of Canada showed one of the highest readings in 17 years.
CAD has also benefited from better risk positioning and a seeming floor under the price of Crude Oil. This effect on oil is evidenced by the improving terms of trade for Canada relative to Australia.
In other words, traders should keep an eye on short opportunities in AUD/cad. While the pair has recently fallen from 102.15 to 98, the pattern may have further downside to that could benefit short sellers who manage their risk well.
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Retail Sentiment Signal on March 12: We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests AUDUSD prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger AUDUSD-bearish contrarian trading bias.
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. Short term momentum helps short-term traders find higher probability trading opportunities.
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.
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---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.
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