Trading Forex and Market Psychology

Today's post is a rather timely one in terms of what is currently happening in the market. So if you are reading this after May 17, 2010, you'll need to adjust your charts to be sure that you're seeing what we are seeing today.

The euro has spent months being trashed by the dollar. The problems in the euro union are finally coming to light. Just today, a governor from the Royal Bank of Scotland have stated that the euro at 1.15 is reasonable. The euro is presently trading at 1.24oo. So he looks for another drop of 9 cents or a $9000.00 profit on a standard trade. I would not be surprised to see that price before this is over, and frankly, I will look for it to go even lower.

The euro's recent strength, trading as high as 1.51, was greatly over played. Here's why. The euro as an economy is now the "largest" in the world, as measured by raw Gross Domestic Product. In other words they produce more than the United States. Everyone expected this growth to continue, and looking forward at the US with its addiction to spending and throwing money at any problem, it's ballooning debt, and the foolishness of recent administrations, the euro seemed the likely counter trade to the dollar.

Thus the dollar was dumped and the euro was purchased, discounting the European problems. But what you sow you eventually reap. And the eurozone had been planting borrowed money for some time. Their harvest was a crop of debt laden interest which will eventually produce defacto defaults. But while the euro was on it's power run, all these troubles were discounted. But the biggest part of the problem was the euro getting stronger.

While this is a benefit to euro consumers purchasing imported goods, it is an impossible situation for governments who borrow money at one rate and expect to pay it off with cheaper (inflated) euros. As long as the euro was strengthening, the individual governments' debt crises was worsening. The only way to resolve it was to weaken the euro. Given the counter-party relationship that the euro has with the dollar, that could only mean that the dollar would have to go up. Now we have a new problem. The only hope that the US has of being able to service its debt is with inflated dollars. Inflated dollars means cheaper currency. So it has turned into a battle of who will be the weakest.

The "advantage" for the euro, is that it is not a reserve currency. Nobody really cares how "low" it goes. The US dollar, on the other hand, is the reserve currency of the world. Namely, it is the currency in which multiple commodity contracts are completed. So as the dollar gets cheaper, sovereign governments all over the world will buy it up in order to secure a better pricing mechanisms for their purchases. this buying will strengthen the dollar as demand for it increases.

So that what we could be seeing here is the slow cold shoulder being given to the euro. It is dispensable as a currency, whereas the US dollar, in spite of it's troubles is not.

Market psychology goes a long way to mediating these imbalances. As the dollar gets stronger, eventually buyers stop coming to the market to purchase them. Of course, where there are no bidders for an item, the item's value begins to fall. We have been on a six month run on dollar strength and euro weakness. At some point, traders will begin to assess the imbalance and turn the trade the other way. Also, it is necessary that the US government see a weakening dollar in order to have any hope at all to meet their obligations.