Here's how to trade them.
Scenario 1: BOE, or Bank of England, nothing, and the European Central Bank, or ECB, does nothing.
Scenario 2: BOE increases quantitative easing, ECB does nothing.
Scenario 3: BOE does nothing, ECB cuts rates.
Scenario 4: BOE increases quantitative easing, ECB cuts rates.
I believe Scenario 4 provides the best trading opportunity for these central bank events. The tricky part is how to interpret what the ECB rate cuts mean. The market could initially sell the euro against the British pound on the announcement, thinking that the ECB is reducing interest rate differentials in favor of the UK. This should drive down EUR against GBP. However, I think that cooler heads will prevail and realize that the ECB cutting rates is a sign of the central bank coming to the aid of European banks, and that the move will lead to rallies in European bank stocks and equities. Therefore, we want to buy EUR against GBP on a dip. Let's use the following levels: Entry 0.8550 (a dip from current spot); a stop at 0.8500; and a target price of 0.8700.
This trade is against the trend and therefore we want to keep stops tight. If it doesn't work quickly, we want to exit quickly to reduce our risk.
Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.
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Learn more: The essential vocabulary for currency trading is on Key Currency Terms. Top strategies are broken down for you in Currency Class.
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