Trading EURUSD and the Government Bubble

I’m watching the EURUSD trade which is currently at $1.5042. Not surprisingly, futures are up. The ES is currently up +8. There is no major economic or earnings news this morning so barring an exogenous event causing a strengthening Dollar I would expect the markets to open to the upside this morning.

I am very confident that a market tied solely to the movement of the Dollar is not a healthy market. It feels very similar to 1999 when cooler heads knew the parabolic rise was not healthy yet the market continued to climb for a long time in spite of those cries for reasonableness. After all, this is how bubbles work. That was the Internet bubble, this is the Government Bubble.

So how do you successfully trade the government bubble?

My opinion is that there were two trends to follow in 2009. All other fundamental and technical analysis was of somewhat limited use this year. MV wrote a post about it yesterday.  The first trend was buying “junk longs.” These were generally well known companies that had fallen into single digits because of bankruptcy risk. While it was possible that a few companies might have declared bankruptcy, it was very unlikely that 100 of the largest companies would go under. So you could buy 50-100 of these names with the expectation of a few 50-75% losses but some 300-400% gains on the others. This trade started in November-December of 2008 (before the bottom) and ended in July 2009.

The second trend to ride which is still going strong was simply staying long the market via SPY, IWM, DIA and QQQQ and using the 50-day SMA on $USDUPX as a stop-loss.

This trend and trade has been in place since April of 2009. I previously mentioned this strategy but I admit that I didn’t stay focused enough to follow it. I was also a little off using the trendline when the real support/resistance levels appears to be the 50-day SMA.

So where do we go from here? As you can see, $USDUPX is inching closer to support at $54. I’m comfortable with my forecast from Sunday which called for immediate term strength and intermediate term weakness. If you’re not currently long, I wouldn’t get long just yet since I think the Dollar will at least consolidate at support.

We’re all afraid to be the “stupid one” that jumps on a trend at the end. So we tend to avoid obvious trends if we’re not one of the early adopters. In hindsight, we often look back and realize that there was plenty of trend left to ride if we would have jumped on when we noticed it. For example, many didn’t see the “junk long” trade opportunity at the end of 2008 but you could have jumped into this trade in April or May and still made some money even after it was obvious to most traders.  I discussed this back in August in a post called “Don’t Worry About Being a Sucker.”

So if $USDUPX does break through support at $54, my plan is to jump on this long established trend and ride the market long until such time as that 50-day SMA is broken on $USDUPX. Keep in mind that with all the talk of Dollar weakness we still have not even breached the lows of 2008. So we’re not in unchartered waters and presumably there is room for the Dollar to drop even further. We haven’t even taken out the 2008 lows yet. So perhaps Bernanke, Geithner and Co. will be comfortable with letting this run even lower. The reason the market is taking off is because they have given the green light on the Dollar carry trade.

But, caution and risk management must be used with this trend. Because I can tell you this, this trade is not a unique idea. When this trade finally does unravel, the market could move down quickly as everyone heads for the exit at the same time. Then we might finally get an Xtrends type drop.

The overnight ES range as of 7:11 ET is 1093-1102. If this holds, I think today has the possibility to be another strong rally since this move higher would take out a lot of stops in place at key resistance levels. For example, the QQQQs are trading at about $44 in the pre-market which would easily take out the October highs on that index.

UPDATE: Bespoke has post demonstrating what it is like to invest in S&P 500 from a foreign perspective. The returns are not as rosy once you factor in currency risk.