Why Mark Twain Thinks a Major EURUSD Bottom May be Near

The inimatable American author Mark Twain once counseled, “Whenever you find yourself on the side of the majority, it is time to pause and reflect.” This is, of course, great advice for life on the whole, but it has very specific application to trading in particular.

Flash back to six months ago: EURUSD was the king of the forex world. Rates had just rallied to a 3-year high at 1.40 and the consensus trade was that the rally would stretch into the end of the year. As any experienced trader will tell you, these are precisely the times when a market is most vulnerable to a reversal. Sure enough, the pair reversed sharply off a multi-year bearish trend line and dropped through its rising wedge pattern in May, starting a six-month cascade of lower highs and lower lows down to the low-1.22s.

Now, as we head into the end of the year, the exact opposite situation is developing: the consensus 2015 trade in the forex market is to be short EURUSD. At first glance, this is a very logical view: the US economy is accelerating, prompting speculation that the Federal Reserve will hike rates in the first six months of 2015, while the Eurozone is struggling with lackluster growth and fears of outright deflation, with most traders pricing in the start of sovereign quantitative easing (QE) program from the ECB in Q1.

Recalling Twain’s wise words though, it’s worthwhile to pause and reflect on the bearish-EURUSD outlook. EURUSD has already dropped a staggering 1,800 pips in the last seven months of 2014, and sentiment is near an historic bearish extreme. The CFTC’s Commitment of Trader data shows that speculative futures traders are net short EURUSD to the tune of 200,000 contracts, the most extreme positioning since the 2012 low. Extending the comparison to May, rates are now approaching a multi-year bullish trend line near 1.2200 and forming a falling wedge pattern (bullish). The pair’s weekly and daily RSI indicators are both showing bullish divergences, suggesting that the bears are losing momentum heading into key trend line support.

With the pair putting in a weekly bullish Piercing Candle* this week, it’s worth wondering: Have we seen a major bottom in EURUSD? While its certainly possible, it would be prudent for traders to wait for more evidence of a trough heading into the end of the year. For instance, the May reversal saw a failed breakout from the long-term trend line before reversing back lower; a similar false breakdown below 1.2200 in the coming weeks would go a long way to confirming a bottom. Alternatively, a conclusive break above the falling wedge pattern (at say, 1.2500) would be a strong bullish sign as well.

I fully expect the majority of traders to have a visceral negative reaction to this article, but perhaps that’s the point: “Whenever you find yourself on the side of the majority, it is time to pause and reflect.” At minimum, I hope that this note prompts traders to pause and reflect on the potential for a EURUSD rally in 2015.

*A Piercing Candle is formed when a candle trades below the previous candle's low, but buyers step in and push rates up to close in the upper half of the previous candle's range. It suggests a potential bullish trend reversal.