Risk Aversion is King!

As currency traders, we do not like governments to intervene in the global markets. These interventions force us to unwind positions that would have paid well without central bank intervention.  

The recent Swiss peg to the Euro forced traders to move out of the Franc to the USD. Some traders may have been holding positions for weeks and were obliged to unwind them, forcing them to close positions that had huge unrealized profits before the intervention.

As you know, the major Central Banks; the European Central Bank (ECB), the Federal Reserve, the Bank of Canada (BoC), the Bank of England (BoE), the Bank of Japan (BoJ) and the Swiss National Bank (SNB) announced that it will conduct three US dollar tenders, each at a term approximately three months covering the end of the year.

This action will facilitate the lending of USD to any European bank that needs cash. This action was taken because US money market funds are refusing to lend to European Banks. They believe that certain banks wouldn’t be able to survive a sovereign default or a euro crisis. Why should they do it? Since major European banks are in trouble. It is important to note that Central Banks don’t conduct that sort of intervention unless something is up, and most probably something very serious will hit the market soon. The last time we saw this kind of intervention was three years ago when Lehman Brothers went under and initiated a global chain reaction. This time it’s a little different though. Back in 2008, they waited for Lehman to collapse before they did anything. A few days before the collapse, Henry Paulson (US Secretary of the Treasury back then) said that the US economy was very solid. This time is different as they are taking measures before any bank fails.

On the other hand, three years ago, the policy response was very decisive and quick. Troubled banks were recapitalized while now, politicians are more focused on their national fights. But, everybody agrees on one thing; the path to recovery is much narrower than before and getting narrower by the day. IMF Lagarde and many others have expressed how urgent it is to get all the parties to agree on a unified action plan.

It is important to note that the actual European problem is different from what happened in the US as here, the real problem is a lot more than banking liquidity, it’s the big possibility of a sovereign default that would initiate a chain reaction that can end up putting the European currency in real trouble.

As Forex traders, we have to put ourselves on the correct side. And that correct side is buying risk aversion currencies, mainly the USD. Not to mention selling the Euro. Despite some upside spikes in EUR/USD when Central Banks inject money in the market, the general trend is dominated by the market psychology which is at the time a fear of a European financial crisis, default… whatever you prefer to call it. It’s the kind of period where short term fundamental analysis and technical analysis doesn’t work. Only market psychology is in play at these times. You can prove this yourself; just track economic releases’ effect on markets, they won’t have significant effect… When this happens, you know that it’s time to follow price action and market psychology closely.

We’ve talked about Black Swans last week. We’ve also talked about positive Black Swans which are unexpected events that would affect your trading account positively. As a trader, you always need to expose yourself to the most probable event that could occur. For the time being, a default would be an unusual event but even if it doesn’t happen for some reason or some intervention, we’re heading to a European financial crisis that would last at least few years. If you try to put yourself in the mind of investors, you will be sure that the euro would be the last currency they would invest in. Risk aversion is king and it will stay like this for some time despite some short term changes.

The Ecofin didn’t come up with anything concrete during their week end meeting which was translated with risk aversion gaps all over the place. Will they get filled? Probably, but currency pairs will make quick risk-off moves very quickly.

I think my trading plan is very clear; short euro after every retrace. Very simple!

GBP/USD touched our 1.5865 level to the pip on Thursday, after the intervention to retrace all the way down making new lows.

As always, use good money management and do not over-leverage your account.