Betting Against the Euro's Rebound

03/30/2009 1:00 pm EST

Focus: ETFS

Doug Fabian

Editor, Successful ETF Investing, ETF Trader's Edge, Weekly ETF Report, and

Doug Fabian, editor of Doug Fabian’s ETF Trader, says the unified currency may have more problems than the greenback, and he recommends an ETF that shorts it.

The [recent] big sell-off in the dollar drove the price of the euro up substantially against the greenback. But that strong euro vs. dollar situation actually sets up a low-risk buying opportunity in a fund that moves twice the inverse of the euro/dollar price change.

That’s why I want you to buy the UltraShort Euro ProShares (NYSEArca: EUO), a fund that’s designed to move twice the inverse of the euro/US dollar price change. So, if the euro falls 2% vs. the dollar, EUO will rise 4%.

There are two primary reasons why I like this EUO buy right now. First, the fundamentals of Europe’s economies are in even worse shape than the US economy’s ailing fundamentals. Plus, the euro is particularly vulnerable due to a lack of a cohesive central bank. The current economic woes in Europe are bound to put more pressure on the region's currency going forward.

The second reason why I like the EUO play here is due to its ultra low RSI (relative strength index) rating. This is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions.  

Usually, an asset is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for a pullback. On the flip side, when the RSI approaches 30, it’s an indication that the asset may be getting oversold and therefore likely to become undervalued.

If you take a look at the charts of EUO and the second of the Currency Shares Euro Trust (NYSEArca: FXE), we see two diametrically opposed RSI levels.

The current RSI of EUO is 30.62, meaning we are seeing a classic case of an oversold asset due for a bounce. With FXE, we have the reverse situation: FXE's RSI is at 70.39. This means the euro is highly overbought and due for a pullback. That pullback in the euro is what we are positioned to profit from with our EUO purchase.

Now for those of you who may have been anticipating going long the US equity market here, rest assured we are looking for the right opportunities. Unfortunately, given [the recent] sharp move higher, going long now would mean taking on far too much risk. Like our EUO purchase, we want to get into equities when the market pulls back.

Finally, we do think the market is due for a pullback here, and when it does we will pull the trigger on several long ETFs. Until that day, make the move into EUO and start profiting from [the] euro/dollar divergence. (It closed just below $22.50 Friday—Editor.)

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