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Busch: How to Trade the Euro on an Outside Reversal

Wednesday, 23 May 2012 | 3:01 PM ET
Reichstag Parliment building, Berlin, Germany
Martin Child | Photodisc | Getty Images
Reichstag Parliment building, Berlin, Germany

Thursday has a large batch of German economic data. Here's how to trade the euro on the news.

Here’s the information for today’s EUR trade. This isn’t a complicated strategy: go with the trend until proven wrong.

Thursday has a large batch of German economic data:

Q1 final GDP is expected to be +1.7%

May PMI manufacturing is expected to be 47.0

May PMI services is expected to be 52.0

If any of these miss, we want to sell the euro against the dollar. The trend is down and the market will attempt to sell all rallies.

Trade sell EUR/buy USD

  • Entry 1.2775
  • S/L 1.2825
  • T/P 1.2625

While the entry point may seem impossible to reach, here’s how it could happen: outside reversal day. If we get an outside reversal, this is the trade you want.

In technical analysis, a simple outside reversal is when the price puts in a lower low and closes above the previous days’ close. (Same for higher high and then a lower close than the previous day’s close.) On May 18th, the EUR/USD put in a lower low at 1.2640 and then closed at 1.2782 above the previous day’s close (5/17) at 1.2693. This led to a rally on 5/19 and a higher close at 1.2812. Obviously, this rally didn’t last as the EUR tanked yesterday. Yet, it’s important to note when these outside reversals begin to develop and try to utilize them in trading. Note, the last outside reversal occurred on May 1st and pointed to a drop in the EUR. Subsequently, the EUR tanked. Therefore at the minimum, we should be on the lookout for outside reversals and see if they work.

For the more risk seeking, the timing on outside reversals can be a way to get the biggest bang for your buck. During the day, you can watch to see if you put in a lower low and then begin to retrace back to the previous day’s close. If this occurs, then you can put the trade on before you actually get the higher close. This is risky as many times the previous close is resistance to the upside. However, this enhances the return as well as witnessed by the movements on May 18. If you are trading an outside reversal, the stop is always below the new low (or high) that was set that day.

For the trade above, we want the outside reversal to happen to get the EUR higher to sell it ahead of economic data. This is just one of the many ways to use an outside reversal.

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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