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Bullish Bets on Euro May Be Bad Sign for Rally

As stocks soared today on the latest burst of optimism about Europe, retail currency traders upped their bets on the euro. But investing pros warn that may not be such a good thing.

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While there are still 1.5 short bets on the euro for every long bet, the balance shifted this week, according to data provided by FXCM, a forex brokerage firm. On Tuesday, before it was reported that European leaders were prepared to increase the European Financial Stability Facility’s emergency fund to 2 trillion euros, there were 1.9 short bets for every long bet. Within minutes of the news, the ratio fell to 1.7. By Wednesday, the total number of FXCM’s clients with positions in the euro had jumped a whopping 20%.

The steady rise in bullish bets on the euro actually serves as a warning for investors, says David Song, a currency analyst for FXCM’s DailyFX.com. Retail currency traders typically bet the wrong way, making their positions a contrarian indicator that might suggest the euro is due for another plunge. “All this hope leaves a lot of room for disappointment,” Song says.

The euro fell rose .08% today against the dollar. But after an up-and-down week, the currency finished flat for the week. So far this year the euro is up 3%, despite falling nearly 5% since the end of August.

Another drop in the euro would be a signal that investors aren’t confident in the prospects for a real solution to the debt crisis, say experts. It would also deepen losses for American investors who hold mutual funds or exchange-traded funds that invest in European stocks. And despite the encouraging headlines today, the fundamental picture in Europe really hasn’t changed, Song says. There are still a lot of political differences to iron out before a real plan to increase the bailout fund can be finalized, he says. And unfortunately, any disappointment would likely hit stocks as well as currencies, he says. “Across the financial industry, the European Union will affect all global markets going forward,” he says.

European leaders are holding a summit meeting this weekend, but according to a report in the Wall Street Journal , France and Germany have already said they won’t be able to work out all the details by Monday; representatives from the two countries say the actual plan will be figured out at another summit next week.

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