3 Reasons Why You Should Short the Aussie

 1.The COT Report Has Hit An Extreme Top

If you remember your lessons from the School of Pipsology, then you'd know that the Commitment of Traders of Report can be a very helpful tool in spotting sentiment extremes. By looking at the net position of currency futures trader, it can help you pick potential tops and bottoms in the spot currency market.

Here's a chart from TimingCharts of AUD/USD and the net position of AUD futures traders:

Looking at the chart, it looks like AUD futures just hit a sentiment extreme a few weeks back. On April 12, speculators were net long 90,651 contracts, with a whopping 93.7% of total contracts being long ones. But of course, this isn't enough to say whether we've really seen a top.

I decided to calculate the %long contracts from April 13, 2010, which was the sentiment extreme last year. After doing some simple math, I found that speculators were net long 88,635, with 91.7% of all contracts being under the long column.

Do you know what this means? Not only did AUD traders have more net long contracts this past April, but we also had a larger long ratio! This means that there's a greater chance that we've just seen a top!

Take note that AUD/USD dropped 1,000 pips after futures contracts hit a sentiment extreme in 2010. Now that the pair has tested psychological resistance at 1.1000, could we see similar drop this year? Parity anyone?

2. Gold Could Break A Rising Trend Line

Over the past four and half months, gold has been as scorching hot as my new favorite Hollywood actress Natalie Portman. After trading just above the 1,300 handle earlier this year, the pair soared to as high as 1,575 before giving back some of its gains.

Gold's steady rise has played a big part in giving the Aussie a boost up the charts. No surprise there - after all, the Aussie is highly correlated to gold.

What would happen though, if gold prices were to suddenly fall?

"Yo Mr. Gump! Look at that uptrend! You really think that gold prices will fall?!?"

Yes, gold's on fire, and has bounced from a rising trend line four times already. But you know what they say - the stronger a support or resistance level is, the stronger the break once the line fails to hold! With gold making lower highs, a fifth test of the trend line may be just around the corner. If the support level fails to hold, we could see a major drop in gold prices. Don't be surprised if the Aussie follows suit!

3. Risk Sentiment: Turning Sour

Over the past couple of weeks, risk aversion has come back in vogue as European sovereign debt fears have returned to haunt the markets. Not only is Portugal getting bailed out, but chances are that Greece will have to restructure its debt as well.

In addition, mixed Chinese data released earlier this week has sparked concerns about Chinese growth. With China being one of Australia's largest trade partners, any decline in Chinese demand could adversely affect the Australian economy.

With trouble potentially brewing both in Asia and Europe, traders might just go back into risk hibernation mode. Naturally, this wouldn't bode well for the Australian dollar.

Now, as convincing as my arguments to sell the Aussie are, you gotta remember that this is from a contrarian point of view. As I've said before, it can be very difficult to go against what everyone else around you is doing. Just keep in mind that if you do happen to catch a top, you might be swimming in large pool pips when it's all said and done!