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Pairs to Range Trade

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A EURUSD Range Trade With A Breakout Contingency

Mon, Nov 17 2008, 05:31 GMT
by John Kicklighter

DailyFX

Usually, when the market’s most heavily traded currency pair stands as a good range candidate, it suggests that overall market is experiencing congestion. However, our interest in a short-term EURUSD range is attractive only when we account for a potential breakout. That is exactly what our suggested strategy takes into account.

Why Would EURUSD Stay in a Range?

• Levels to Watch:
  -Range Top: 1.2850 (Trend, Fib, Swing High)
  -Range Bottom: 1.2330 (Pivot)

• The epitome of liquidity and direction for the industrialized components of the currency market, EURUSD continues to cut a volatile range. Friday’s event reflects the even fundamental standing both the Euro Zone and US share. The former has confirmed its recession and the latter is accelerating into its own economic slump. The US is the source of the liquidity crisis, but this is easily balanced out by the fact the ECB has a lot more room to cut rates.

• For a setup, EURUSD’s descending wedge offers a clear congestion trade (that could setup up a profitable breakout position under the right circumstances). Resistance is predominately in a falling trend line from Oct 1st (with five tests), but has a solid base in a nearby fib at 1.2280. Main support is a long-term pivot at 1.2475.

Suggested Strategy

• Short: Entry orders will be set at 1.2815 is set well enough below the trendline to be triggered.

• Stop: The initial stop is set above the Nov 11th swing high at 1.2945. To protect profit, we will move the stop on the second lot to breakeven when the first target is hit.

• Target: The first objective equals risk (130) at 1.2685. The second target will be 1.2555.

Trading Tip – Usually, when the market’s most heavily traded currency pair stands as a good range candidate, it suggests that overall market is experiencing congestion. However, our interest in a short-term EURUSD range is attractive only when we taken into account the potential for a near-term breakout. That is exactly what our suggested strategy takes into account. Congestion in the currency market is prevalent; but a look to the level of volatility underlying price action and the steady deterioration of the global economic forecast suggests breakouts are highly probable across the board. From a fundamental standpoint, we would expect a rise in risk aversion to swell; and technically, EURUSD is at the bottom of its dominant bear-trend and developing a short-term descending wedge. Both sides of the analysis spectrum are leaning towards a downside breakout; and that is why we are only looking for a short position on the developing range (trailing the stop on our second lot could open door to riding any bearish breakout momentum). To reduce risk, we will cancel open orders by Tuesday’s close or should spot hit 1.24 first.

Event Risk Euro Zone And US

Euro Zone – Bigger fundamental themes are beginning to drive euro price action – namely: interest rate expectations and fading forecasts for an economic recession. With the GDP numbers from the EZ confirming a technical recession this week - and data further bolstering expectations for worst through the next two quarters - the probability that the ECB will turn to aggressive rate cuts is growing quickly. The growth outlook will be a major economic driver long after the interest rate factor has evaporated. In times of fear and market-wide risk unwinding, investors are less concerned with returns and more concerned with forecasting how long and severe the depression will be. This is an ongoing issue for all economies and currencies; but for the euro, a few key economic indicators will help adjust the baring on forecasts. PMI readings, confidence surveys and the OECD’s growth forecast for November will cover everything.

US – When determining the main fundamental driver of the US dollar, we merely need to look at the currency’s long-term direction. As it is clearly bullish until this point, we know that risk sentiment is overshadowing concerns such near record lows on interest rates and expectations for a harsh economic recession. Therefore, we know the G20 meeting that will be wrapped up by Saturday could hold significant probabilities for volatility. Though these meetings don’t often offer worthwhile results (and especially not the level of help needed by the markets today), there is always the probability of something more significant than the market is pricing in. Moving down our list of priorities, the road markings for the eventual rebound of the oncoming recession and ongoing interest rate slump will fall to inflation and housing data. The CPI numbers will not only provide scope for the Fed reaching 0.50 percent, it will also establish the cost of living for consumers – the life blood of the economy.

Published on  Mon, Nov 17 2008, 05:36 GMT