One of the most potent market moving events for the EURUSD, EURJPY, and EURCHF is today’s ECB press conference that follows its announcement on interest rates, which are expected to remain unchanged.
If you’ve ever been tempted to try trading the short term trends generated by news events, I’ve found a relatively new trading vehicle for private traders (the big boys know it well) that you’ll want to consider, binary options.
Binary Options, News Trading, & Further Reading
Binary options are an alternative to the traditional spot trading vehicles for forex (also stocks, stock indexes, commodities, and more) that has only recently come to the retail market.
Informed traders should get to know them for many reasons.
They can be a real weapon in your arsenal in certain situations.
Below we discuss one of them – their unique suitability for trading off of news events, and a practical example to consider this week.
Binary options are often an ideal vehicle for news traders because there are so few decisions to make, so it’s easy to move fast and quickly exploit or hedge a short term trend or price movement.
- The only big decision traders really need make is about the direction of the trend within a given time frame, which can be as short as 5-60 minutes. There is no need to consider stop losses or exit points. Unlike traditional spot forex, there is no such thing as being right about the trend in your chosen time frame but STILL losing money from hitting a stop loss too early.
Have I gotten your attention, oh long-suffering short-term traders? I know, there now, please, here’s a hankie.
- They eliminate most of the complex risk management decisions needed for serious spot forex (or other kinds of short term trading) while retaining (and at times improving on) the very high profit potential of leverage common in spot forex.
- That profit potential is becoming harder to find as regulators in the US and elsewhere move to limit the leverage allowed in traditional retail spot market trading for forex, stocks, indexes, etc.
- With such short expiration times (though at least one broker offers up to one month for playing longer term trends), traders can trade very focused time frames without being glued to their computers. One they’ve bought a call binary option (to profit from a rising trend) or a put (to play a drop in price) their work is over.
Like any other trading vehicle, they have their limitations and disadvantages. However most of those don’t apply to news traders, who are by definition accustomed to the demands and risks of short term trading.
Background: Why Central Bank Press Conferences Can Move Markets
While rate announcements usually don’t surprise markets, the accompanying press conferences are often very significant because they provide clues about central bank intentions for the future. Markets can and do move when they perceive hints of a policy change.
If they believe the comments reflect a coming hawkish (pro interest rate increase) shift in policy, the currency in question rises on projected higher future demand for its higher yields. If comments suggest a more dovish (favoring current or lower short term rates) the opposite happens.
Rising Optimism About Growth, Rate Hikes Overcome EU Debt Worries
The EURUSD and EURJPY have been in rally mode for the past 7 weeks. Click to enlarge:
EURUSD AND EURJPY WEEKLY CHARTS COURTESY OF ANYOPTION.COM 03feb28 1927
This uptrend is impressive, considering how it has progressed despite a continued deterioration in the EU debt and banking crisis that has featured:
- German opposition to any measures that would significantly help the PIIGS block stay solvent
- Rising PIIGS bond rates, making future borrowing (mostly to roll over maturing debt into new bonds) more expensive and pushing them closer to insolvency
- The rising prospect that the newly elected Irish government would seek to ‘renegotiate’ (i.e. partially default) on its current debt obligations per the bailout arranged a few months back. The Irish finance ministry has halted cash infusions to Irish banks over the past weeks until the new government’s position on payments to bank bondholders is clarified.
Note however, that markets have not forgotten about the EU debt crisis. The EURCHF has struggled even though the CHF tends to underperform the EUR when stocks are rising. That suggests these rallies in the EURUSD and EURJPY were partly due to the similarly dire long term fundamentals of the US and Japanese economies. In contrast, the Swiss economy is far healthier and less debt burdened than that of the EZ, US, or Japan.
Rising Optimism and ECB Rate Expectations Support The Euro
However anxiety over the EU crisis was overcome by:
- Rising Overall Market Optimism (Aka Risk Appetite)
Risk appetite, as depicted by most major international stock indexes, has been rising steadily since September, on a combination of slowly improving economic data and heavy stimulus measures from the Fed and even the supposedly ‘hard money’ ECB, which was merrily buying up dubious quality PIIGS bonds and lending to less credit worthy PIIGS banks to keep debt markets calm. The EURUSD and EURJPY tends to rise when optimism, and thus stocks, are on the upswing.
Note what’s happened with our favorite single picture of risk appetite, the S&P 500. Click to enlarge:
S&P 500 DAILY CHART COURTESY OF ANYOPTION.COM 04FEB 28 1939
As a testimony to the technical strength of risk appetite since September, (leaving aside last week’s potentially game-changing events in the Mideast-North Africa (MENA) region last week) note that:
- Until last week, the index spend almost the entire 6 month period within the top range of the 1 and 2 standard deviation Bollinger Bands, (the upper 2 green lines), an indication of trend strength
- The index tested support of its 50 day moving average only briefly in November
- Growing Belief In Coming ECB Rate Hikes
In recent weeks, evidence of rising inflation, and comments from a number of ECB officials, have fed speculation that the ECB is moving closer to raising short term rates more quickly than the Fed or Bank of Japan.
Why Thursday’s ECB Press Conference Could Set EURUSD, EURJPY Trends
Are EUR rates due to increase soon? The next big hint comes later today, at the Thursday March 3rd ECB rate statement and press conference. The ECB doesn’t like surprising the markets, and is generally careful to telegraph its intentions. High expectations have been priced into the EUR in recent weeks.
If ECB President Trichet appears more in favor of rate hikes the EUR could potentially test 1.4000 resistance. If not, expect a pullback to test support around 1.3550, or even lower if MENA region turmoil continues to feed risk aversion.
Interpreting Trichet, & How To Play, Si Vous Plait
If he emphasizes concerns about inflation over EU economic weakness (due to the PIIGS or spiking oil prices), markets are likely to interpret that as hawkish, that he is now more inclined to raise interest rates. Per Kathy Lien of fx360.com, the magic word to listen for will be “vigilance” regarding inflation.
That will be bullish for the EURUSD and other EUR pairs. Those BO traders working on one hour or one day time frames might consider riding the likely EURUSD and EURJPY uptrend by purchasing binary option calls.
If he avoids this kind of language, or in any way suggests the need for caution on raising rates (f/e.g. says rate increase could hurt the PIIGS) then look for the EUR to retreat.
Binary option traders would look to exploit the likely EURUSD and EURJPY down trend over the coming hours or day by purchasing binary option puts.
The key to success at any kind of short term trading is to follow the trend the market gives us, so regardless of how one may interpret Trichet, keep a careful eye on short term EURUSD and EURJPY charts (1- 120 minute charts) following the announcement to determine the market’s interpretation of his comments. That’s the only one that really matters.
Experienced forex traders can of course directly trade the EURUSD and EURJPY.
Those more comfortable with stocks can play via:
The Related ETFs
- Long the EUR: FXE, ERO, EU, UDN (a short USD ETF that will benefit from a rising EUR)
- Short the EUR: EUO, UUP (a long USD ETF that benefits from a falling EUR)
Major EU Banks
Remember that higher EUR rates, while good for the EUR, are bad for EU stocks and anything related to the PIIGS or their bondholders. So ECB hawkishness means pressure on bellwether EU stocks connected to PIIGS bonds – like any major EU bank.
Thus a hawkish ECB suggests downtrends for stocks in major EU banks like Deutsche Bank (NYSE:DB) and Banco Santander (STD). A dovish outcome is bullish for these.
The ECB decision of course does not occur in a vacuum. Consider other market movers that could well be present.
- Risk Aversion
As noted above, the EURUSD and EURJPY tend to move higher with rising optimism and vice versa. Thus if we get a major piece of bad news, that could override whatever Monsieur Trichet says. Likely sources of bad news are numerous, including:
- New threats to oil production from MENA (Mideast North Africa) unrest
- Rising EU debt anxiety on fear that the new Irish government’s campaign promise to renegotiate (partially default on) its debt could bring a wave of similar moves from other PIIGS and destabilize the EU banking system (which holds most of this dubious debt).
- North Korean saber rattling gets more serious
- Strong US Jobs Report
Remember, the EUR and USD tend to push each other in opposite directions, like children on a seesaw. See What Will Reverse the U.S. Dollar Downtrend? for details on why.
Even if the ECB indeed gets hawkish, if the US job reports that come the next day in fact show the expected significant improvement, the USD could strengthen and quickly spark profit taking in the EURUSD.
The monthly US jobs reports are arguably the mother of all news trading events, so stay tuned for our take on playing that one too.
Growing Hints Of QE 3
Yes, it’s being discussed, see here for details. If that is seen as increasingly likely over the course of the week, it’s another blow to the USD, and more support for the EUR.
Our Take: ECB More Likely To Disappoint, Send EUR Lower
Higher EUR rates would be yet another blow to the PIIGS.
- They would drive up the EUR and make the PIIGS nations even less competitive
- They would further hamper growth by raising credit costs for the private sector throughout the EZ.
- They would force PIIGS already high sovereign borrowing costs up even more
Risk Of Inflation Vs. Risk of ECB’s Own ‘Days Of Rage’?
Given the dire economic condition of the PIIGS, and the new Irish government’s mandate to get militant with their EU creditors, the ECB risks sparking its own ‘day of rage’ with Ireland and possibly other PIIGS nations. Thus we suspect the ECB will choose to risk inflation in the future rather than a crisis now, and hold off on rate increases in the near term, at least until the affects of new austerity measures in the EU and direction of oil prices becomes clearer.
Note as well that higher interest rates are more affective at fighting consumer demand-driven inflation than they are against inflation due to rising commodity prices. So higher rates may carry far more risk than reward for the EZ.
DISCLOSURE & DISCLAIMER: AUTHOR SHORT THE EUR FOR PERSONAL PORTFOLIO. THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY AND NOT TO BE CONSTRUED AS SPECIFIC TRADING ADVICE. RESPONSIBILITY FOR TRADE DECISIONS IS SOLELY WITH THE READER