Euro trade gets crowded—could it bring pain?

Should markets brace for another ECB letdown?

The euro zone's single currency hovered around a one-year low against the dollar on Tuesday as investors continued to dump the euro in anticipation of extra liquidity in the region. However, one analyst has warned of a crowded trade that could spell pain for some investors if this downward move isn't treated with caution.

The euro hit a session low of 1.3178 against the greenback on Tuesday morning, the lowest level since early September last year. Against the Swiss franc it was trading at levels not seen since January 2013.

With a dovish speech by Mario Draghi, the president of the European Central Bank (ECB), on Friday raising the prospects that a major asset purchase program could be just around the corner, traders are almost unanimous in believing the single currency will push lower. This week, soft business sentiment data from Germany and a political crisis unfolding in France have further compounded the move lower.

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Crowded position?

Meanwhile, Wall Street speculators increased their short positions on the euro last week, according U.S. Commodity Futures Trading Commission data. This was the largest net euro short position since July 31, 2012, and this week's numbers are widely expected to reveal a similar pattern.

"(The euro) could well be on its way towards the 1.3000 level, which would be a 50 percent retracement of the move from the 2012 lows at 1.2042 to the 1.3993 highs earlier this year," Michael Hewson, a market strategist at CMC Markets said in a morning note.

Marshall Gittler, the head of global FX strategy at IronFX believes that the overall picture for the euro is to the downside and noted that a "decisive dip" below 1.3185 in the near future could see scope for extensions towards the next support line of 1.3100.

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'No brainer' trade

The Governing Council of the central bank will meet once again next week although no announcement on quantitative easing is expected. Analysts at Japanese investment bank Nomura revised their predictions on Monday and now believe that the ECB could produce a further cut to interest rates next week.

The general outlook may be negative for the euro - with the anticipated flood of liquidity from ECB asset purchases meaning it would become less desirable for investors to hold - but some are more cautious believing that the market is positioned to be disappointed.

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Greg Matwejev, the director of FX hedge fund sales and trading at brokerage Newedge, told CNBC that the market is currently "massively skewed" and expects the euro to retest the 1.3440 level after next week's rate decision.

"(Draghi) gets a lot of value for money from jawboning, he does it exceptionally well and I think he'll continue to do that," he said.

"Being short at the wrong levels is going to be exceptionally painful...It's a 'no brainer trade' but it's just the timing and how fast we'll actually get those lower levels."