Earlier this week I pointed out a pullback scenario on EUR/GBP with nice potential. Is it another opportunity to play the downtrend or reversal in the making?
I’m going with a mostly technical setup here, with a hint of positive interest rate carry and divergence to potentially fuel a continued move lower.
On the one hour forex chart above, we can see that the market is hitting my weekly horizontal lines, as well as widely watched retracement levels using the Fib tool. The previous week high (PWH) and top WATR level is an area that mean revision traders may be checking out, which lines up the Fibonacci retracement levels that trend traders may be checking out. Again, this isn’t a guarantee of a reversal, but the more traders that are watching, the more may be acting, which means a higher probability of this area holding and reversing.
I like this short fundamentally because of the divergence in outlook on monetary policy between the European Central Bank (recently cutting interest rates; recent weak economic data) and the Bank of England (speculated to raise rates as economic recovery improves). Of course, no one knows what the future hold, but as for now, it looks like this is the course of action for both central banks for at least the next few months, unless we get a shock in economic data.
My one concern is that the speculation of a rate hike by the BOE may be fully priced in and overdone (which is why we may be seeing a turn higher) but I think the pressure will remain to the downside for EUR/GBP on interest rate differential alone. That’s why I’m going in with a scale in technique instead of full position all at once. My stop is one full WATR from the averaged-in price of my multiple entries to give the trade room to breath, and my target is the recent swing lows. I’m keeping my PT’s tight because of the summer season (typically rangebound behavior and low liquidity). Here’s what I am going to do:
Short half position EUR/GBP at market (.8025), stop at .8135, profit target at .7965
Short half position EUR/GBP at market (.8075), stop at .8135, profit target at .7965
If both positions are triggered, my average position price is .8050, and with this trade structure, I have a potential reward-to-risk ratio of about 1:1 on 1.00% account risk. If the market does get to .7965, I’ll re-assess to see if it makes sense to take profit or continue to hold (and scale in more) if the odds are favorable for a move lower. Of course, anything can happen in the forex markets, so if the story changes I’ll be sure to reassess and adjust quickly if necessary. Stay tuned!
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