The Euro Bounce: A Bear Market Rally or the Start of Something Bigger?

Several weeks ago, with the Euro trading around 1.19 versus the dollar, weeks of European discontent, and media pundits unanimously declaring the End of the Euro, I wrote in my article “End of the Euro? Not so Fast,” that we could be in fact very close to a reversal. I cited the extreme in negative sentiment as a key factor alerting me to a chance of a reversal, and the trade worked out beautifully.

What followed, almost on cue, was that the Euro ripped higher off of the 1.19 low, as illustrated in the chart below, in a three-week rally closing at about 1.24 on June 25. Clearly the Euro, if it is going down, is not doing so without a fight.

And that of course leads us to the broader question; is this 4% bounce just a bear market rally or the beginning of something bigger? Well, once again it is incredibly difficult to predict the long term, but based on the data, I believe that this rally has further to go.

Below is the updated COT report for the Euro which was shown in my first article. You will notice that soon after the EU announced its trillion dollar plan on May 10 the large speculators (the green line) began to reverse their selling pattern that had been in place for six months. This occurred while the Euro headed lower. Most people at the time dismissed this EU plan as vague and condemned to be as ineffective as the U.S. TARP plan, which in my opinion was quite effective but that is another discussion. The winners in the Euro trade (large speculators) almost immediately began covering their positions, handing it off to others who suddenly wanted to participate in a crumbling Euro, which is represented by the green line turning up. As you can see, the large specs now have been continuing this action for six weeks while the Euro has rallied the last three weeks when I first pointed out this development in the COT readings.

There were also some other important things happening at the Euro low. Notice the charts of the Swiss Franc and the Euro below. As you can see, the Swiss and the Euro are closely correlated, but the Swiss put the bottom in on June 1 while the Euro put the low in on June 7. The Euro’s final plunge hit lower lows while the Swiss held previous lows should be seen as the capitulation low.  Divergences between these two currencies historically have been very meaningful, with the Swiss Franc being a leading indicator.

Source:Barcharts.com

Source:Barcharts.com

Finally, there is the sentiment on the Euro. The bearishness in the Euro is extreme. Even after this three-week rally the naysayers continue to command center stage.  

Trading is more of an art than a science being that technicals and fundamentals can be viewed in many ways predicting many outcomes. My interpretation of the Euro at this point is the risk/reward is heavily on the bull’s side.

Bruce Gwyn 
Managing Partner
Level III Trading 

web: http://www.level3trading.com
email: bgwyn@level3trading.com