Why I’m Shorting This Currency Pair

07/11/2012 8:00 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

This trade could really benefit later in the week from its interplay with the US dollar, writes Kathy Lien.

My trade of the week on CNBC’s Money in Motion recently was to sell EUR/JPY. It was a jam-packed show and my window to talk about the trade was short. Therefore, I want to take this opportunity to explain in further detail why I really like this trade, particularly since it’s finally rebounding and could potentially trigger an entry.

On the show, I said trading EUR weakness through EUR/JPY is the best of both worlds because we can take advantage of

  • Lower EUR for European weakness
  • Stronger JPY for risk aversion, weaker global growth, and softer Chinese data

The great thing about trading EUR/JPY is that it benefits from a sell-off in EUR/USD or a sell-off in USD/JPY, so if this week’s FOMC minutes confirm that QE3 is still on the table, it will also help our trade.

If you know me, then you know that when I identify trades, I always look at it from three perspectives: fundamentals, technicals, and sentiment.

1. Fundamentals
Spanish bond yields are back on the rise, and I don’t expect much from Monday’s EZ Fin Min meeting, which should be bearish for EUR.

Renewed expectations for QE3 should weigh on the US dollar, with the FOMC minutes as a potential catalyst for driving USD/JPY lower.

If this week’s Chinese data surprises to the downside, it could set off a wave of risk aversion that will drive JPY higher.

2. Technicals
EUR/JPY broke its one-month low, which opens the door to a move down to 97 and possibly even a move below 96 (as Todd Gordon pointed out). As you can see in the chart below, EUR/JPY is in a “downtrend” according to my Double Bollinger Bands.

While 97 is my target, there’s no real support in EUR/JPY until the 11-year low of 95.60.

3. Sentiment
Investor sentiment or what I call the “flow” is on our side with the sharp sell-off in EUR/JPY.

EURJPY is the quintessential “risk off” trade, which means that it traditionally underperforms when investors are nervous. Given the extreme pessimism of the ECB and other central bank officials, the possibility of weakness could raise the level of anxiety in the market and help my EUR/JPY trade call.

These were the levels that I provided on CNBC:

  • Sell EUR/JPY at 98.25
  • Set your stop loss at 99.00
  • Trade target is 97.00

Here is a chart to show the above graphically:

chart
Click to Enlarge

Kathy Lien can be found at KathyLien.com.

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