EUR/USD Staging Major Breakout
As is often the case, the EUR/USD is being viewed as one of the leading forex pairs in terms of the ways it is defining the broader trends that are seen elsewhere in the market. But what has caught many traders by surprise is the fact that it is the EUR that is leading the way and taking the greenback along for a turbulent ride in the process. The EUR/USD is currently staging a major breakout that is likely to catch many forex traders long or short at the wrong levels for anyone that is trying to chase the moves. This means it is important to exercise patience and conduct the required technical analysis in order to identify profitable positions and avoid being stopped out at a loss.
Daily Chart: EUR/USD
Zooming into the daily charts in the EUR/USD we can see that several critical technical levels have been broken in the current moves. The medium-term downtrend that has been in place since May 2016 has now been largely violated as the series of lower highs no longer paints an accurate picture of the trend. These types of moves are very forceful and lead to volatility in both directions once traders start to take profits and exit long positions.
From an indicator perspective, we can see that the latest rallies in the EUR/USD have forced both the Commodity Channel Index (CCI) and the Stochastic RSI out of their mid-ranges and into the areas which suggest overbought market activity. To be sure, these are clearly bullish moves but what this ultimately suggests is that long positions should be taken with caution. It is also absolutely critical to employ protective stop losses in these types of situations so that you are able to avoid large losses if the market begins to whipsaw. These types of scenarios can make or break a trading account, so avoid jumping into reckless positions (chasing the market) at any and all costs.
Now that we have covered the underlying trend break in the medium-term downtrend, it is important to confirm the validity of these moves using other structural price events. From a support and resistance perspective, prices are currently grinding through the failure zone from last November, which defined a clear resistance point just above 1.1140.
Keep in mind that this was another volatile price area that made it somewhat complicated when defining critical resistance points. Following the activity in November, we saw a violent price spike into the 1.13 region but this was also followed by quick losses. This ultimately means that these levels were not sustainable, and it is more than likely that a large portion of the forex market was stopped out on the expectation that a major trend change was occurring.
Defining the Underlying Trend in EUR/USD
This, of course, is another reason forex traders should approach these moves with caution. But there are also reasons to believe that this current move is different and that we are in store for much higher values in the Euro.
Any time we see trend changes of this magnitude, it is always important to have an understanding of the fundamental drivers that are fueling the move. Currently, we see support for the Euro on several fronts. The passage of recent elections suggests that a major event risk has passed and that a large element of uncertainty has now been removed from the market. This should ultimately mean that large fund names will be less reluctant to hold large positions in Euro-related assets.
In addition this, we are seeing arguments from influential policymakers in the region which suggest that the current direction in monetary policy is due for a change. Specifically, the broad disconnect between what has been outlined by the Federal Reserve and the ECB is another important factor that is likely to reverse course as quantitative easing stimulus programs are less necessary. The German deputy Finance Minister made recent comments that the ECB should exit these programs sooner rather than later — and this is something that should prove to be bullish for the Euro. Going forward, forex traders will need to remain cognizant of these events in order to confirm or deny the validity of the latest price moves in the EUR/USD.
On their own, major breakouts in trendlines and support and resistance zones are useful. But trading strategies have an even higher probability of success when combined with alternate analysis strategies. We have an example that meets these criteria in the current analysis with the 61.8% Fibonacci break of the move that dominated the prior trend (decline from 1.1616 to 1.0340). This is arguably the most commonly watched Fibonacci price level, so the resistance break here ultimately suggests a move to at least 1.1350 (which is the 78.6% retracement of the aforementioned move).
This would ultimately equate to a rally of roughly 200 pips. Using a 3:1 risk-to-reward ratio, this means traders should employ a stop loss of no more than 70 pips when structuring a trade.
Avoiding Risk Factors
Long trades here in the EUR/USD look solid from both a technical and fundamental perspective but there are risk factors that should be considered. The massive spike has created overbought indicator readings that will need to unwind before taking any significant positions. We also have price activity piercing through the upper levels in a 2-deviation Bollinger Band, and this is generally something that is unsustainable.
Here, trading strategies can be conducted in one of two ways:
- We can start getting long at current levels using smaller position sizes
- We can wait for price retracements back toward resistance-turned-support levels (allowing indicator readings to unwind)
The first strategy above is preferable for traders with a more aggressive trading stance. The second strategy is preferable for traders with a more conservative trading stance. If you are looking to operate using the second strategy, watch for a price retracement back toward 1.1060 for buy entries. This type of strategy would allow for larger stop loss levels, given the fact that the upside target would then be nearly 300 pips higher. This suggests a stop loss of 1.0960, which is also attractive given the fact that we would than be well below the 1.1000 psychological figure.
The first strategy is a bit more complicated and involves more active management. The advantage, however, is the fact that you are guaranteed a trade entry at 1.1155. Since we are entering at higher levels, there is more potential risk for decline so we will look to open a ⅓ position size with a stop loss below 1.0980. We are able to use this larger stop loss because we are looking to average out to an average position size that is roughly 70 pips from the stop loss.
Essentially, this strategy requires us to set additional buy orders at 1.1080 and 1.1020. All position entries are of equal size, so you will be looking to establish ⅓ of your position in each trade entry. In the charts above, we can see that the psychological 1.10 level worked as resistance previously and this is why we will now expect it to act as support going forward. The bullish trading bias will be reversed if we see a price decline through the 1.10, and so this is why we will not hold long positions if the EUR/USD falls through this area.