For today’s “Pick,” I’d like to study price action in AUD/USD as we saw a nice one way move after breaking the tight Asia session range and Friday’s high. This is a great chance to study the simple “Break and Retest” strategy for a nice return-on-risk.
Before you move on, for those who are not familiar with my framework, signals, setups, or acronyms, please visit my discretionary day trading blog here.
Again, this is a simple trade setup as explained in our “Trading Breakouts” lesson in the School of Pipsology. First, the previous day high (PDH) was tested during the morning European trading session. When it broke after being retested again, the tendency for the market is to turn this area to support (ie a buy area).
Now, how do we know this price action was better suited for a breakout play rather than a reversal. A couple things could have tipped you off.
First, Friday’s price action range was 66 pips–much less than the current average daily volatility of around +103 pips. Second, the Asia session range was about +40 pips, much less than the 77 pips average for that session.
So, with the pair consolidating on the previous day and during the Asia session, the chances of a breakout were much higher. And that’s what we got as the pair broke Asia session highs and the previous day high, with the help of bearish dollar sentiment, to run up all the way to parity (1.0000). Of course, being THE major psychologically significant level for any pair, this level help plenty of sell orders to stop the rally. There were indications that this was the case with a doji and stochastics showing us the rally ran out of steam.
How could you have played it for a high return risk?
As soon, as the pair broke back above the previous day high, you could have bought at the open of the next candle (.9925). I like to use 1/4 or 1/3 of the daily average true range as my stop, so I picked 25 pips for this example. I would add another “Unit” every 25 pips higher (for those unfamiliar with my scaling in trade management technique, please see a detailed example here). This would have lead to a nice 6:1 reward-to-risk return. Not bad for a days work.
So, what’s the lesson for today?
If market ranges are tight the day before and/or during the Asia session, be sure to think about a breakout strategy. Got it? Good!