Short covering happens when a large number of speculative traders, those in the hedge funds and other institutions who take big bets on the likely direction of a currency, are forced to reverse their positions because price has started to move against them so that they must either cut their losses or cash in whatever paper profits they have accrued. If this happens on an occasion when the overriding sentiment in the market place is either up or down, the result can be a large surge in the opposite direction to the one held. This is known as a short squeeze. Purchases to close out short positions are still purchases, and market forces will behave accordingly.
The US Commodity Futures Trading Commission (CFTC), a government agency, reports each week on the Commitment of Traders to the likely direction of a large number of commodity futures, including currency futures. The Forex broker, Oanda, uses this information to compile the chart at the top of this article. This shows that right now the overwhelming tendency is for institutional traders to hold short positions – in other words to be betting that the Euro will fall further. Whether they are right or wrong, the fact that the position is so biased in that one direction has created the conditions that are ripe for a short-squeeze.
Euro is poised for change
The EURUSD pair has been resisting the temptation to go below the 1.11 near-record low it recorded in January (see above). In the meantime, there are indications that the economic situation in the Euro zone might not be as bad as it has been perceived to be, as we pointed out recently (Reuters: Things are looking up in Europe too). Add in the fact that the Greek drama seems to be on the back burner, at least for the time being, that Eurozone QE is now a done deal, and that, if anything, the FOMC in the US has the luxury, because of low inflation, of postponing the normalisation of monetary policy, and one could be forgiven for thinking that the conditions could be just right for a retrace in the current trend of the Single Currency.
Possibly even for a short squeeze.