While lower prices in the S&P 500 will certainly inflict more pain to the ‘long only’ equity crowd, it will continue to offer good insights on how to play the FX market as most major pairs are very correlated with the S&P 500 presently.

It is interesting to note however, that the downside action in EUR/USD was muted today despite the strong dollar (DXC) and weak S&P 500. In discussing this with colleagues we are all a bit uneasy about EUR/USD’s current price action. The last 12-24 hours have essentially provided only a series of overlapping waves which are corrective, but do not fit into the normal sequence that one would expect at this juncture of the move.

A second re-test of the October 10th low at 839.80 is appearing more likely. As was noted in this letter a couple of weeks back, the previous two data points historically that likely mimic the current situation suggest a re-test then either a gradual sideways recovery or a sharp move higher as we saw in 1987. Hence, a second re-test would put us back to merely looking at the charts rather than relying on historical data to forecast what may happen. Under this scenario, one would have to conclude that lower prices are in the cards.

Add to this the fact that implied volatility (IV) values for the major pairs and EUR/USD are becoming rather expensive and it may suggest that the market is now valuing quite highly hedges on their existing ‘short dollar’ positions. While IV values alone are not a stand-alone indicator, at this time they are merely confirming some general gut feels regarding EUR/USD and perhaps the limited downside for the time being.

While I rarely will attempt to pick bottoms, I have been short EUR/USD since 1.2790 and have now lowered my stops to account for the potential rebound in EUR/USD. Traders who have been looking to get short EUR/USD may wish to re-evaluate that idea – the move lower has been generous and with the points noted above, shorts may be a lower probability play presently. Nonetheless, the market may continue lower and today will have been nothing more than a blip on the radar screen. A decisive break below 1.2470 exposes 1.2374/50.

By Dave Floyd
Head of FX Research
Aspen Trading Group