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Readying Trades for Volatility and Event Risk

Readying Trades for Volatility and Event Risk

2012-09-05 19:37:00
John Kicklighter, Chief Strategist

I have been waiting to shift gears in my trading approach for some time (the month-long low liquidity and low trend generation potential contradicts my normal swing-trade approach). However, it looks like we slowly starting to make that shift from congestion to breakouts and soon more meaningful swings (if not trend generation).

So far this week, my approach has still run to the congestion setups. My recent trades have all fallen into the short-term. A EURUSD long from from 1.2530 was directed at the pair pulling back into congestion after a slide and hitting the floor of a short-term rising trend channel. This setup was well-founded given trading conditions and technicals, but I also made a poor decision related to this trade. Though the correlation is high (I don't like to leverage up the same theme), I decided before turning the computer off for the night to take along EURJPY trade (from 98.05) on its own range. The trade paid off (hitting the target at 98.90), but it contradicted a general rule I consider critical. I won't lament a winning trade, but I can't deem it a complete, 'good' trade.

The other short-term trade that I had took Tuesday was a long USDCAD from 0.9850 (off the floor of a long-term congestion pattern). From a period that is not conducive to meaningful breakouts and a pair that is congestion prone, this seemed a sound approach. With a run to the top of a lower time frame wedge pattern, I took half off (for 65 pips) and trailed the stop to break even on the remainder. Given the event risk coming up, there is potential for a big break an considerable upside progress; but I'm going to make sure there is no risk on trying to speculate on a 50/50 event.

The first step to a change in trading tack from annoying congestion, is tentative breakouts and moderate follow through. Looking ahead to next week, we have very serious event risk - the kind that can truly alter the outlook for the entire financial markets by ramping up stimulus or revealing to traders that lackluster growth will not find external help (Fed rate decision, G20 meeting, EU Summit). That means, I means that big trend setups are not the best approach through the end of the week, but volatility and moderate breakouts/trends are possible given certain event risk.

My interest is primarily in the ECB rate decision. Once again, speculation is heavy heading into this event, and that means a big reaction from the euro is likely despite the outcome. I prefer playing an influx in volatility with a EURJPY. The 100 pip range over the past two weeks is highly irregular and sets clearly defined points for a break. I'll first make sure the outcome for the ECB is considered decisive (bullish or bearish) and then play a break above 99.00 or below 98.00 accordingly. It will be important to take profit along the way, so a first target should be set within 100 pips. EURUSD is another potential, but it will likely require more of a push to break its 1.2625 - 1.2500 range. EURGBP reduces the risk element to focus on the Euro crisis. A break of an 11-month channel above 0.7955 is a bullish option and move below 0.7900 is the bearish scenario. EURCAD is attractive only on a pro-Euro / little risk impact scenario with a break above 1.2500. Even EURCHF looks interesting.

There are other trades out there that are still attractive and move away from the Euro crisis. GBPAUD is a heavily overbought pair that will eventually reverse - it just needs a catalyst. Have to be careful about moving to early on this one.

AUDUSD and AUDCAD are other reversal threats (but the latter looks much better on a weekly chart with a big head-and-shoulders neckline to play out over the longer-term). Then there are those that are are less prone to risk trends and immediate event risk, but there are very few with immediately attractive tech setups. I still like my GBPCAD long and AUDNZD looks interesting around 1.2800.

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