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Selective Countertrend Set-up in EUR/AUD

Selective Countertrend Set-up in EUR/AUD

2014-01-22 03:45:00
Todd Gordon, Technical Strategist

Talking Points:

  • Longer-Term Uptrend in EUR/AUD
  • Elliott Patterns That Support the Short Side
  • Step-by-Step Parameters for Taking This Trade

While EURAUD has risen strongly for almost 18 months, this set-up involves a potential countertrend trade with a favorable risk profile. It doesn’t require trying to “pick a top” in search of a huge home run, but it’s worth considering nonetheless.

The daily chart below shows that EURAUD made a low near 1.16 in August 2012 and was supported by an uptrend line. The pair then rose by 34% to reach the late-December-2013 high at 1.5596.

We’re not suggesting that the uptrend has ended, however, or that 1.5596 is a significant top. Instead, with no evidence to the contrary, we’re presuming that the uptrend is likely still in progress, but because price is currently a long way above the trend line (after a sharp rise from early November), there is an opportunity for EURAUD to correct back to the trend line.

Guest Commentary: 17-Month Uptrend in EUR/AUD

Selective_Countertrend_Set-up_in_EURAUD_body_GuestCommentary_ToddGordon_January21B_1.png, Selective Countertrend Set-up in EUR/AUD

The daily analysis alone, however, isn’t enough to formulate a trade plan, so we’ll also use Elliott wave analysis from the 1.5596 high to see if there might be a wave count confirming the case for a move lower, even if only a short-term corrective one.

The below six-hour chart beginning at the 1.5596 high sees a sharp impulsive move down to 1.5115. We don’t know if this is the start of a new impulsive move lower or the start of a correction, so we’ll call it “(i)” or “(a).” Price then moves in a three-wave (yellow a-b-c) expanded flat to 1.5507, which we’ll call “(ii)” or “(b).”

The conservative count considers this a corrective wave (blue (a)-(b)-(c)). During the expanded flat, EURAUD made a low of 1.5029.

Guest Commentary: Elliott Wave Price Action in EUR/AUD

Selective_Countertrend_Set-up_in_EURAUD_body_GuestCommentary_ToddGordon_January21B_2.png, Selective Countertrend Set-up in EUR/AUD

Since the recent high at 1.5507, price has moved lower to 1.5336 in what seems to be five small waves. From there, it appears to be correcting higher, which provides an opportunity to set up and enter a short trade.

From an Elliott wave perspective, the move lower to 1.5336 is a first (yellow) wave from 1.5507. A second-wave pullback seems to be in progress, which typically retraces 50%-61.8% of the first wave.

Short Trade Idea for EUR/AUD

To trade EURAUD on the short side right now, we’ll nominate a limit entry at 1.5435. Our stop will be placed above the recent high at 1.5515 (which also allows for the spread). With an 80-pip stop, we’re looking for one or more targets at least 120 pips away (at least 50% larger than the size of the stop).

As we’re calling this a corrective move, the move from 1.5507 should at least move below the recent low of 1.5029. Therefore, we’re going to nominate two targets, the first being 1.5195 (240 pips away), and the second at 1.5035 (just above the recent 1.5029 low), which is 400 pips below the entry.

How to Effectively Manage Risk

The risk profile for both of these positions is unusually high (3:1 and 5:1, respectively). This is deliberate because as a countertrend trade, it carries higher risk than trading with the trend.

This also allows us to place a smaller position size than normal (say, 30%-50% of a typical trade). By risking less, if the trade goes against us, our account is reduced by a fraction of our typical trade risk. However, if the trade succeeds, our account is increased by a “typical” trade profit. Regardless, more conservative traders may choose to pass on this set-up.

Step-by-Step Trade Parameters

  • Position Size: Risk between 30% and 50% of a “normal” position
  • Trade: Sell EURAUD at 1.5435
  • Stop Loss: Place stop at 1.5515
  • Trade Targets: Two separate target levels, the first being 1.5195 and the second 1.5035
  • Trade Management: If price reaches 1.5195, lower the stop from 1.5515 to 1.5435

By Todd Gordon, founder, TradingAnalysis.com

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Disclaimer: Trading foreign exchange on margin carries a high level of risk and may not be suitable for all investors.

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