Euro Weakness Offers Trading Opportunity

Frankfurt (Aug 17)  Interest rates on German 10-year bonds have fallen below 1% for the first time in history. The decline in interest rates came after news of disappointing economic growth in Europe. Some analysts believe the slow growth will require the European Central Bank to take more aggressive stimulus action. Concerns about additional easing have pressured the euro which is down more than 2% in the past six weeks, a significant move in the currency markets.

Because moves in currencies tend to be small, many traders in those markets use leverage. This can be done directly in the foreign exchange markets, in the futures markets or with leveraged ETFs. Each of these options has advantages and disadvantages. One of the common characteristics among the trading opportunities is that there are ample opportunities to benefit from price increases on the long side and price declines on the short side.

The euro’s rapid down move has set up a potential trading opportunity in a leveraged, inverse ETF, ProShares UltraShort Euro (NYSE: EUO). The chart of EUO is shown below.

euo

As the euro fell, EUO rose as expected. The uptrend was marked by a large number of days when the PowerRatings fell to 1 or 2, setting up a short-term sell signal. Heading into Monday’s open, EUO has a PowerRatings of 8 which indicates it is oversold and a potential buy. This is a classic mean reversion, long trade setup since we have a pullback in a long-term uptrend.

The long-term uptrend can be seen on the chart. The short-term pullback is identified with PowerRatings which are based on the relationship between price and the 5-day moving average (MA) of price. The further prices move away from the 5-day MA, the stronger the tendency to snap back becomes. PowerRatings uses the 5-day MA and several other components to identify high probability trade entry points. This strategy was thoroughly back tested and the history of over 4 million trades was analyzed.

We know from back testing that PowerRatings can be used as the basis of a trading strategy. Detailed back testing has confirmed that the higher the rating, the greater the one week historical gain has been for stocks and ETFs with that rating. For best results, enter trades on stocks with a PowerRatings of 8 or higher with a limit order 3-7% below the previous day’s closing price. Higher % limit entries have historically shown a greater percentage of winning trades but higher % limit orders also reduce the chance of trade execution.

As an example of a trading strategy that can be used, in the past, buying stocks with a rating of 8, on a 5% pullback the next day and selling after the stock closes above its 5-day simple moving average has been profitable 72% of the time with an average gain of 3.9%. Other entries and exits also show high winning percentages and large average gains.

Source: TradingMarkets