How to choose the market that matches your convictions

MOST people have a fairly good idea of what is driving the financial markets. But much of the time, only a few are any good at choosing the right market to express their views of what’s going on.

A good example of this is the overly bearish view of the Eurozone throughout 2013 by professional forecasters. While many were anticipating euro weakness, it took until the first quarter of 2014 before we saw a major decline in the euro-dollar, which is now much lower than 2013 levels. But many retail traders who followed the same trade idea are now out of business, as they stubbornly stuck to their euro-dollar short positions.

A better choice would have been to short euro-pound, which peaked in August 2013. This was a whole nine months before euro-dollar peaked. Clearly, the fundamental traders were right in their view to short the euro, but subsequently teaming it up against the dollar was not the wisest choice. Another way of expressing the same idea was to go long on the German Bund – a trade that is still going strong.

So how can the average trader make sure that they are choosing the right market, without the convenient benefit of hindsight? When it comes to the euro case, if you wanted to express your view using FX, then scanning across the many combinations of euro pairs is one solution. You would look across the spectrum of FX pairs and only trade those which were following the trend that coincides with your outlook.

In the instance of the euro-pound, the 20-day moving average was steadily pointing lower in August 2013, which gave us the go-ahead for being short.

Alejandro Zambrano is a currency strategy analyst at DailyFX.com.