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The Most Popular Trade Is Going to Explode... AgainBy Jeff ClarkThursday, May 31, 2012 About every year at this time, currency traders lose their minds... Then they lose their shirts. It's going to happen again this year.
The most popular trade in the currency market right now is to be long the dollar and short the euro. At first glance, this seems like a reasonable trade. After all, Europe is on the brink of collapse. And as the continent dissolves, investors flock to the safety of the U.S. dollar. It's the ultimate "risk-off" trade.
But here's the thing... the world has a habit of not coming to an end.
Think about it. Back in May 2010, Greece was threatening to default on its debts. Spanish banks were in trouble. Ireland, Italy, and Portugal were facing liquidity issues. The dollar rallied 7%-plus that month alone. That's an enormous one-month move for a currency. The most popular trade on the planet was to be long the U.S. dollar and short the euro. I warned at the time the trade was going to blow up.
And it did. The dollar fell 10% over the following two months as traders realized the world wasn't going to end.
Fast-forward to this time last year. The financial disaster in Europe took over the headlines. Greece was threatening to default. Spanish banks were in trouble. Yada yada yada. Once again, traders swarmed to the dollar, and the greenback gained 5% in May.
It gave up all the gains, though, just one month later.
Now, it's the same old story. Once again, the long dollar/short euro trade is the most popular position on the planet. The dollar has rallied 5% this month, and everyone is talking about the euro collapsing.
Yes, it is 2012 – and maybe the Mayans were on to something – but I just don't see Armageddon happening while everyone is looking for it. Financial markets do not reward popular trades. (This month's disastrous Facebook IPO is a good example of that.) So while everyone is looking for continued dollar strength and euro weakness, I think the better idea is to do the opposite...
I'm not quite ready to buy the euro yet. Its downtrend is extended. But it hasn't quite reached the oversold levels it hit in 2010. And with the Greek election coming up in mid-June, there's plenty of time for some more downside volatility... but probably not much more.
Over the next two weeks, I'll be looking for opportunities to put risk back on. Everything that sold off this month as the dollar rallied is going to rally when the "long dollar/short euro" trade blows up. Get ready for a hard bounce in commodities and stocks and a hard fall in bonds and the dollar.
Best regards and good trading,
Jeff Clark
Further Reading:
Jeff expects gold stocks to rally along with commodities over the next couple weeks. "This doesn't mean you should rush out and pile your entire life's savings into the gold sector," he says. "But gold stocks are off to a promising start... And it's worth the risk for traders to add some gold exposure to their portfolios." Get the story here: Gold Stocks Have Officially Broken Out.
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