A LOT of people revised their outlook for euro-dollar after the less hawkish Federal Open Market Committee meeting two weeks ago. Suddenly, many experts and retail traders felt less comfortable about euro-dollar reaching parity.
In a similar way, the conversation turned more euro-dollar positive in November 2014 as the currency pair stabilised, even though oil prices were tumbling and would surely show up in inflation prints across the world.
This is the point I want to bring home: the markets have a very short memory and like to magnify and extrapolate from recent events. This can be used to your advantage if you are able to sort out the relevant from the irrelevant. While this might seem difficult, people who can do so – and act on it – will reveal their actions in the price charts.
A simple yet powerful tool that can help to reveal the true underlying trend of euro-dollar is the 20-day moving average. As long as it’s pointing lower, we may expect the downtrend to continue. When and if the 20-day moving average turns positive, we may start to consider that euro-dollar will trade higher.
The importance of the 20-day trend can be seen in the following experiment. In one test, a trader opened random long and short positions with a 100 pips stop loss and 100 pip profit target. The results were not positive. In the second test, random trades were also opened, yet only in line with the 20-day trend. Needless to say, this second trader performed much better.
Alejandro Zambrano is a currency strategy analyst at DailyFX.com.