How to Trade on a Rate Cut Down Under

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Australian Flag

Australia's central bank will announce an interest rate decision during Asian trading hours.

Here's how to get ready.

U.S.-based currency investors have their pick of overnight events to trade on this week, from unemployment reports from New Zealand and Germany to the Australian central bank's widely awaited interest rate decision, due around 12:30 a.m. New York time on May 1.

Andrew Busch, global currency and public policy strategist for BMO Capital, says the Australian event "has the biggest potential here," so he has outlined a trading playbook.

Investors have been banking on an interest rate cut from the Reserve Bank of Australia, and Busch says markets are now pricing in a cut of 25 to 30 basis points. If the bank delivers 25 basis points, he told CNBC's Melissa Lee it would make sense to buy the Australian dollar and sell the U.S. dollar.

But Busch wants to trade on the possibility of a bigger, 50-basis-point cut. "I like the second scenario because it's not priced in the market," he says. Since a larger than expected interest rate cut would presumably hurt the Aussie, he wants to sell it against the dollar.

Busch wants to enter the trade at 1.0450 and set a very tight stop at 1.0475, looking for a move to 1.0300. And he wants to put this on right before the interest rate decision.

"This is something that's a little crazy," he says. "When you've got tight ranges you've got to leave tight stops and take advantage of an event like this."

Todd Gordon, co-head of research and trading at Aspen Trading Group, thinks the levels make sense. Looking at technical factors, "the Australian dollar is at a decision point," he says. If it moves above 1.0450 to 1.0475 he is bullish, and if it moves lower, he is bearish.

You can watch the discussion on the video.

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