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Analysis
If you’ve got EUR exposure, be aware this is a news-driven market and with EURUSD overnight implied vols at 52-week highs it could potentially get a little wild out there.
I talked up the idea of momentum trading yesterday and where a momo move can morph into a trend – traders should know the difference between momentum and trending markets – momentum is a vector, meaning in this case it looks at the magnitude in the relative change in price (over a period) of an instrument AND the direction. Today, we look at levels to fade EURUSD strength, as I believe you can and, in many cases, should run multiple strategies – diversification in positions is great but diversification in strategy can be even more powerful.
EURUSD Daily chart
(Source: TradingView - Past performance is not indicative of future performance.)
There's many ways to trade mean reversion – one that seems to be working for now is to use a regression trend (I’ve used TradingView) – it's not so much using a ‘mean’ in a statistical sense but a line of best fit through a trend. Using the current trend from early February we see price working nicely within the regression channel, which adopts (as the default setting) 2 standard deviations of the line of best fit. These relationships obviously do eventually break down, but for now, I would maintain a view that it holds and will fade extremes - buying into 0.9930 and initiating shorts into 1.0460, which also happens to be the 50-day MA, a variable many use as a trend filter.
The options implied vol also tells me that a move above 1.0400 today would be statistically extreme and the prospect of getting there seems remote – still, this is where the conviction is.
Another trade I like that involves mean reversion is Gold (XAUUSD) – while price is trending lower, if I look at the percentage difference between price and the 50-day MA, we see this currently at 6.2%. This is two standard deviations from the long-term average (the blue horizontal line – see the Bloomberg chart below). Typically, when the price gets below the 2 std dev level we see a reversion to the 50-day MA, and this has been caused by price reversing rather than consolidation that leads to the MA playing catch-up.
Gold (XAUUSD) chart
(Source: Bloomberg - Past performance is not indicative of future performance.)
We’re not there yet, but I feel a further flush out to 1680/78 (the August 2021 lows) could be the level that this move is overcooked. One for the radar and you can trade the possibilities with Pepperstone.
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