Hedging Euro Strengh Against the Lira Creates Entry To Yield-Driven Trend

Published August 18th, 2008 - 11:03 GMT

The Euro has been steadily declining against the Lira since mid-April as Turkey’s monetary authorities issued three consecutive interest rate increases to bring borrowing costs to a hefty 16.75%. Deteriorating economic conditions in Euro-Zone fundamentals have only fueled the selloff. Most recently, last week saw EZ Gross Domestic Product numbers come in at a dismal -0.2 percent, the first negative posting in the history of the 15-member bloc. Meanwhile, consumer prices surprised to the downside at -0.2%, opening the door for the ECB to stabilize output with a rate cut. Expectations that the already substantial 12.5% yield gap between the two nations will continue to widen favors a continuation of the current bearish trend.

While Thursday saw Turkey hold off on issuing another rate hike, the pause may be tentative as last Friday’s Unemployment figure saw a marked reduction to 8.9% versus 9.6% in the preceding month. Increasingly tight labor markets will bid up inflationary pressure and may put Turkey’s central bank on the offensive once again.

With the underlying economic outlook favoring the Lira, technical positioning opens the door for a short-term retracement upward. EURTRY price action has been oscillating in a clean descending channel since the start of April. Price action is now positioned at the bottom of this channel, with a corrective retracement upward targeting resistance at 1.8657.
Hedging Strategy

Currency Pair: EURTRY

Long Term Bias: Bearish
Long Term Position: Holding Short

Short Term Bias
: Bullish
Short Term Position: Buy above 1.7425, Target 1.8657, Stop-Loss at 1.6828

Traders looking to protect their existing short EURTRY position or enter short at a favorable price may consider a hedge long EURTRY above 1.7418 with a target at 1.8657. Once the profit target is hit, we expect the bearish trend to resume. We will maintain a stop-loss on our hedge position should EURTRY break out to the downside prior to the limit being hit. We will set the stop-loss near 1.6828.

When should I use the hedging feature?

Markets hardly ever trade in the same direction for long. Though there are general trends that may unfold for weeks, months and years; there is almost always considerable fluctuation in price during these periods – sometimes leading to significant retracements. There are a few common strategies that traders use to immunize their risk to counter-trend moves while still holding to the long-term trend. One method of reacting to these changing tides is to actively enter and exit a trade on each swing, which requires constant attention and a superior ability to pick tops and bottoms. The other, more passive, strategy is to hold on for the long-term trend through retracements in the belief that the higher trend will reengage. Taking a temporary hedge positions through the counter-trend moves, on the other hand, requires less accuracy in picking tops and bottoms and at the same time lowers the drawdown while increasing the potential for return.

The hedging feature is currently available on all accounts using FXCM’s No Dealing Desk service.

For more information on FXCM hedging strategies please visit http://www.fxcm.com/hedging.jsp.

To reach Ilya with comments regarding this or other articles he has authored, please email him at ispivak@dailyfx.com.

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