H&S Forming on the Eurodollar

05/23/2013 9:00 am EST

Focus: FOREX

On the weekly charts, one of the most accurate topping configurations is underway in the eurodollar pair, writes Daniel Hwang of Gallant Capital Markets.

It’s been roughly three months since FX Views has been updated, mainly due to other significant ventures soon to be announced, and of course, a bit of time off from the strains of a 24-hour market. However, sometimes taking a step back allows one to see the bigger picture, which unfortunately still looks to be worrisome for the single currency.

Since early February, the major fundamental themes have not changed much—Europe’s debt crisis continues to weigh on EUR/USD and a loose BOJ has buoyed most G10/JPY and EM/JPY currencies to levels that may potentially be nearing overstretched levels where corrective moves are more likely than not—TBT/JPY seems to be a prime candidate for such a correction.

Rates in both G10 and EM FX have drastically changed, mostly on the back of fundamental drivers. Europe’s fiscal and monetary woes remain unresolved due to the Eurozone’s member states’ propensity to agree to disagree while a looser BOJ and the resultant weaker yen has so far helped Japan’s economy recover as domestic exporters have reaped the rewards of supportive monetary policy. Overall, we think the former (Europe’s woes) will be a consistent theme in FX while the latter (economic benefits of the loose BOJ) may wane in coming months.

FX Views Strategy Update
The technical pictures in FX-land has also undergone some drastic changes, shifted may be a more accurate assessment. Back on Feb. 5, 2013, we outlined potential EUR/USD downside from around the 1.3600 level as providing better than 2:1 risk/reward value for EUR/USD short positions—stops above 1.4200 and limits around 1.1900 for a total risk of 700 pips and total potential reward of 1700 pips.

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Even more encouraging, however, are recent developments seen on longer-term EUR/USD charts. On weekly charts, under development is perhaps one of the most accurate topping configurations…the H&S (head and shoulders) pattern. A weekly close below the neckline around the 1.2800 figure suggests heightened potential for technical downside to extend lower than projected limit targets near the 1.1900 figure from our February 5, 2013, FX Views strategy note to around the 1.1800 figure (see chart below). If the H&S measured move objective holds true, the long-term strategy would reap a potential reward that tallies 18 big figures (1800 pips) in roughly nine months on just one standard contract equating in USD to $18,000.

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While the global foreign exchange market is the most heavily traded and sometimes the most volatile market across asset classes (mainly due to leveraged accounts), it also tends to be one of the best trending markets in the world rendering HFT (high frequency trading) too inefficient on a cost- basis and therefore translating to be likewise on profitability.

So far in 2013, currency funds have dominated the hedge fund world with more than 80% of the best performing hedge funds being those solely trading FX products, many of which utilize trend following strategies. A valuable lesson to be learned, one that many fledgling currency traders learn the hard way is quite cliché. In the long run, however, heeding such advice is most likely to benefit one’s bottom-line—patience is a virtue. A happy trigger finger not only increases trading costs but if comprehensive analysis and focus is not a precursor to pulling trades, intended targets are likely to have a higher probability of not being hit.

By Daniel Hwang, Chief Currency Strategist, Gallant Capital Markets