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Talking Points:

  • There are two types of general market approach for traders/investors: those that 'go with the flow' and contrarian view
  • Statistically-speaking, the trends - whether bullish, bearish or flat - are most common; but conditions for turns do arise
  • We discuss the importance of technicals, fundamentals and positioning confluence against Dollar pairs, gold and Treasuries

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Most of the Time Markets Trend, But for Those Times It Doesn't...

There are 'many ways to skin a cat' as the saying goes; but when you approach the markets, you do so in one of two general approaches: either you conform to the prevailing trend or you attempt to trade against it by timing a reversal. Historically, there is far more consistency in trend versus meaningful market turns - much less systemic reversals - which are relatively more infrequent and sometimes outright rare. If you were looking to explicitly play the percentages, you would seek out those trading opportunities that are ideally positioned to conform technically, fundamental and systemically to the existing trend. Of course, market turns do occur and we would be cutting off considerable opportunity - not to mention undermining our ability to separate genuine from false signal - if we didn't establish means to separate one from the other.

Making the Strongest Statistical Case for a Correction or Reversal

To properly account for a notably diminished probability, seeking out reversals should be a practice of quantitative assessment and strategy as much as possible. As with most trading strategies, discretion and emotion are strong distractions rather than sound foundation for establishing genuine opportunity. It is true that a 'stretch' market for example is better positioned for a correction, but establishing such a qualification is not objective. Technicals are a favorite means upon which to base an assessment of excess. We can do this readily enough in calculating a market's extreme pace by way of simple measures like historical ATR (average true range) or disparity between spot prices and an underlying average like a 100 or 200-day trading average. That said, chart patterns alone make for relatively poor filters. If we add fundamentals and market conditions to the equation, we can materially improve the odds by reducing the underwhelming opportunities. Fundamentals change with focus and circumstance - such as risk trends and trade wars. Yet there is also the ambiguity of speculative exposure. There are readings with a short-term focus which changes the opportunities it is better suited for - as is the case with the DailyFX speculative positioning data. Then there is medium-term skew that comes via the futures market and the trader-favorite COT (Commitment of Trades) report from the CFTC.

Analyzing the Major Dollar Crosses for Contrarian 'Fitness'

If you look to the Dollar as a whole, the picture is rather impressive. On a technical basis, the currency has mounted a hearty recovery through 2018, but its more recent months have turned to consolidation. Fundamentally, the Greenback is lacking for a convincing argument for an unchecked return to trend. The argument that the currency is simply looking to fill in for its shortfall relative to interesting rate expectations seems more explanatory than genuine. That opens the picture to a possible reversal should risk aversion lend the USD a unique status or markets recognize the full effect of trade wars returning back to haunt the US. It is speculative positioning that is growing the most quantitatively extreme however. Collectively, interest in the Dollar has rebound substantially over the past months meaning the low-hanging fruit may already be picked over. For specific pairs, we find speculative positioning conforms differently with other analytical cross measures. Both AUDUSD and NZDUSD have seen a stretched to strong net short exposure - but reversals are tough to establish with rate decisions ahead and risk trends surprising serious confidence. GBPUSD brings more support with an extended trend on dubious clarity through fundamentals - given the persistence of Brexit. I still hold an interest in USDJPY with risk trend in place but a techncal break hasn't accompanied the tentative turn and pro-speculative longs are not yet willing to pursue. Hands down, one of the more remarkable backdrops comes via EURUSD. This benchmark pair has a serious technical floor in 1.15 while fundamentals draw from commitment (better for trend maintenance). It is the positioning which is remarkable as well. EURUSD speculative exposure has dropped from a record high to a level far more contentious in being framed as stretched and primed.

USD/CNH vs. USD/HKD Weekly Chart

Sorting Which Contrarian Readings are Tradeable Among EURUSD, USDJPY, Gold and More

EUR/USD Daily Chart

Sorting Which Contrarian Readings are Tradeable Among EURUSD, USDJPY, Gold and More

A Word to Gold and US Treasuries

Owing to the considerable speculative debate over the US dollar, there is naturally a lot to glean from the positioning statistics available to us. Yet, that isn't the only game in town that is persistently under scrutiny. There are other markets that may offer seemingly unique view of a particular market, but the dollar as an enchor will helped to curb any unexpected circumstances. In the meantime, there are other markets that should be evaluatedd for positioning. Gold has dropped for months to the lowest level since early 2017, but speculative interest has dropped far more agressively than the nascent rallies have been able of taking hold. For the precious metal, the technical and positioning evaluations are severely stretched. Fundamentals can readily support the currency to recovery should the market abandon high-return assets. The same extraordinary criteria suits US Treasuries. Though the 10-year yield has reached a pre-GFC high, we should still evaluate more harshly and thoroughly. We discuss this and more in today's Quick Take Video

Speculative Positioning (Futures, COT) – Gold Chart

Sorting Which Contrarian Readings are Tradeable Among EURUSD, USDJPY, Gold and More

Speculative Positioning (Futures, COT) – US Treasury Yield 10yr Chart

Sorting Which Contrarian Readings are Tradeable Among EURUSD, USDJPY, Gold and More

--- Written by John Kicklighter, Chief Currency Strategist for DailyFX.com