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Pairs to Range Trade

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GBPAUD Range Looks To High Risk, High Reward and a Fast Pace

Thu, Mar 5 2009, 05:56 GMT
by John Kicklighter

DailyFX

The best range trades are placed on low volatility pairs that are set within a clear channel and are clear of notable event risk. By this crude definition, GBPAUD doesn’t seem to present a good candidate. However, the current setup behind this pair offers a better opportunity than what would be considered text book.

Why Would GBPAUD Hold a Range?

• Levels to Watch:
  -Range Top: 2.2650 (Range, SMA, Fib)
  -Range Bottom: 2.1725 (SMA, Fibs, Trend)

• The fundamental trade off between the pound and Aussie dollar is considerable. Market participants have aggressively priced in the worse for the UK in terms of growth and expected rate of return; and now traders are wondering whether an equilibrium has been met where negative indicators no longer have a significant impact on price action – an important considerable for Thursdays’ BoE decision. Confidence in a quick Aussie recovery was driven by the RBA hold, but questioned by GDP figures.

• Ranges conditions are not the norm for GBPAUD. However, the congestion developed between SMAs is well defended. Support is our primary concern with a trend, 50-day SMA, Fib retracement and range low all around 1.1725. With the medium-term rising trend, we further have momentum behind us.

Suggested Strategy

• Long: Half-size entry orders will be placed at 2.1800 to give enough room over recent lows.

• Stop: Our initial stop will be set at 2.1625. This is a notionally wide stop, but not for volatility. To secure profit, move the stop on the second lot to breakeven when the first target hits.

• Target: The first objective equals risk (175) at 2.1975 and the second is set to 2.2175.

Trading Tip – The best range trades are placed on low volatility pairs that are set within a clear channel and are clear of notable event risk. By this crude definition, GBPAUD doesn’t seem to present a good candidate. However, the current setup behind this pair offers a better opportunity than what would be considered text book. For one thing, the technical range that has developed around GBPAUD comes with far greater support than many of the viable channel trades out there. What’s more, a medium term, bullish bias that has developed since the turn of the year leverages the probability of a turn on range support. For event risk, the critical Australian data has already crossed the wires and left its significant impact on price action. The UK docket is still a genuine risk with the MPC expected to deliver its rate decision tomorrow; but since the market has long priced in near-zero interest rates, there is little room for surprise.
Volatility is the true challenge. It will test the technical boundaries of our range; and it creates an issue with trying to limit risk. Our strategy halves position size on orders, widens stops and sets targets at a reasonable level. However, an ill-timed surge spike in volatility could still knock us out.

Event Risk UK And Australia

UK – The United Kingdom is the fundamental laggard of the world economy. Traders wrung the pound for all the bullish sentiment that it carried through the high liquidity and leveraged years that preceded the current financial crisis; and when most of the devaluation was complete, economists and other market participants pegged the currency and its economy as the worst positioned for 2009. However, there is always a point of equilibrium when the negative forecasts are fully priced in. We may have already passed this point with the pound. Already pulling back from record lows, we have seen the pound gain ground as its global counterparts tumbled to meet it. Thursday’s rate cut is already fully priced in (a move down to zero by next month would not surprise). What’s more a deepening contraction is expected.
Therefore, the pound will likely be buffered to negative data and surprised by any positive outcomes.

Australia – Sentiment surrounding the Australian dollar and its economy has changed dramatically this week. Before the heavy-hitting economic data scheduled through the first half of this week crossed the wires, FX traders treated the Aussie dollar as a high-yielder with one of the best performing economies in its region. However, optimism was restrained. In a global recession, these advantages can quickly turn into burdens when the former leader is forced down to the same level of its peers (much like the pound). On Tuesday morning, market participants were offered something tangible when the RBA decided to keep rates unchanged at 3.25 percent. This fed speculation that the currency would not only retain its yield advantage until risk appetite turned around; but that it would also lead the recovery from the global recession. This last consideration was sidelined though by a weaker-than-expected 4Q GDP report; but it has not completely discouraged bulls. Over the coming week, only next Thursday’s employment data can truly add to this sentiment.

Published on  Thu, Mar 5 2009, 06:02 GMT