by SmartMoney
With Europe's debt woes mounting, some savvy currency investors are shorting the euro against the dollar -- a bold bet considering the greenback's own shaky status.
After months of battering, Europe's economy may receive yet another jolt of bad news on Friday: The European Union's banking regulator is scheduled to release the results of bank "stress tests," aimed at showing which banks have enough cash to withstand another crisis. About 12 to 15 banks are expected to fail the tests, but any additional failures are likely to fuel doubts about the euro, says Brian Dolan, the chief currency strategist for Forex.com. Retail currency traders at forex brokerage firm FXCM had been largely betting on the euro against the dollar until this morning, when they flipped to being net short the euro, says David Song, a currency analyst for the firm's daily commentary site, DailyFX.com.
The stress tests are only the latest in a long series of tests for the euro. The region's sovereign debt crisis has been unfolding for more than a year, with both Greece and Ireland receiving bailouts and rising fears that Spain and Italy will soon need them, too. On Thursday, an Italian bond auction saw yields on the country's five- and 15-year bonds hit three-year highs, indicating growing concern about sovereign debt that extends beyond Greece. The euro fell to a seven-week low this week, but is still up 6% for the year over the struggling U.S. dollar.
To short the euro, investors with a foreign-exchange trading accounts could simply sell the euro against the dollar leading into Friday's announcement. "More people are coming around to the view that Greece has to default," says Andrew Busch, a global currency strategist for BMO Capital Markets. "That's why I want to continue to try to sell euros on rallies," Busch says. Keep in mind that currency trades use leverage, and that currency markets move quickly and significant moves can appear small to new traders. For example, at the maximum 50-to-1 leverage offered by U.S. forex dealers, a typical trader could be making or losing thousands of dollars on one-cent moves in exchange rates. For his part, Busch recommends taking profits after about a 4-cent slide and setting a stop-loss to exit the trade after about a 1-cent rise in the euro.
Investors without forex accounts can use a currency exchange-traded fund like the Pro-Shares Ultra Short Euro (EUO: 17.56, -0.03, -0.17%) or the Market Vectors Double Short Euro (DRR: 39.25, 0.04, 0.10%). Experts caution: These are leveraged ETFs that track daily moves in the currency, so they also can generate significant losses or gains on seemingly small moves. For example, the Market Vectors product should rise 2% for every 1-cent drop in the price of the euro against the dollar.
Despite the significant troubles facing the euro zone, betting against the currency is far from a sure thing. The fact that retail traders have started shorting the euro is actually a contrarian indicator that might suggest the euro is due for another rally, Song says. Some pros also warn against betting on the dollar, considering the U.S.'s escalating troubles, including the fast-approaching deadline for raising the debt ceiling and signals that the Federal Reserve won't raise interest rates any time soon, Dolan says. That's creating something of a see-saw between the dollar and the euro, as fresh bad news hits one currency or the other in turn, Busch says. "It's what I'd call dueling debt banjos," he says. The third, and perhaps safest option, say some traders: The yen. "Given the uncertainty in this environment it's probably better to be selling risk," Dolan says, meaning selling currencies that fall when investors get nervous, like the Australian or New Zealand dollars, or the iffy euro, versus the relatively safer yen.
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