A Sound Strategy Could Take Advantage of a Wide NZD/USD Range

01/23/2009 11:07 am EST

Focus: FOREX

The sting of high volatility and the broad wave of risk aversion that swept over the market yesterday is a viable threat for any potential range trades. For NZD/USD's broad price band, the conflict between technicals and fundamentals will have to be skewed by a sound setup.

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Why Would NZD/USD Hold a Range?

Levels to Watch:
-Range Top: 0.6085 (Fib, Range High, SMA)
-Range Bottom: 0.5200 (Triple Bottom)

Swings in risk sentiment are vital to the direction NZD/USD takes going forward. While the fear-driven decline from Wednesday may seem to have lost its momentum, it is still a risky proposition to position against such a heady trend when volatility is still very high and many pairs are hanging on the edge of significant breaks in favor of risk aversion. Aside from this background influence, we also have to take care of the RBNZ rate decision and US GDP figures.

While volatility is still very high across the currency market, and momentum behind the recent NZD/USD downswing has not been fully sidelined, the pair is nonetheless coming upon significant support. A triple bottom would be set with a confirmed reversal in this phase of the pair's broad range. It should also be said that this is a six-year low with few levels below.

Suggested Strategy|pagebreak|

Long: Half-sized entry orders will be set at 0.5235 to offer an entry that fits our risk profile.  

Stop: An initial stop at 0.5105 is wide enough to cover our range and provide a buffer to volatility. To secure profit, move the stop on the second lot to breakeven when the first target hits.

Target: The first objective equals risk (120) at 0.5355. The second target will be 0.5535.


Trading Tip - The sting of high volatility and the broad wave of risk aversion that swept over the market yesterday is a viable threat for any potential range trades. For NZD/USD's broad price band, the conflict between technicals and fundamentals will have to be skewed by a sound setup. From our suggested strategy, we take the more aggressive approach-an entry that is very close to support that further allows for a wider stop and reasonable targets. To minimize notional risk, we are taking a position that is only half our normal size. For those that are more cautious, we can alter the setup to look for confirmation of a medium-term trend reversal (momentum is arguably still bearish) while maintaining a reasonable risk profile. Different people have different views on what makes for a good confirmation on trend changes, but a reasonable trigger for this setup could be an hourly bar close above the falling trend line that has defined the medium-term bear wave, or perhaps a close above nearby resistance at 0.5350. A stop could be set below short-term technical levels or the larger range bottom, but position size should be adjusted appropriately so that total notional risk is acceptable. We will cancel open orders by Friday's close.

Event Risk: New Zealand and US

New Zealand - Event risk looks to pick up after the weekend, but for the time frame of our open orders, there is no specific piece of scheduled event risk that threatens to drive this pair to a breakout or revive a trend. This does not mean we could not see a significant move from behind the kiwi, however. This currency has a high correlation to general risk trends thanks to its high benchmark lending rate and significant amount of foreign capital that flows into the economy, specifically for investment yields. On the other hand, it is difficult to forecast a specific driver for risk trends going forward. One indicator that may fill this role though is the advanced reading on fourth quarter UK GDP. As the first G10 nation to release its growth numbers, it will set the tone for global recession forecasts. Looking beyond the weekend, an active position will find some potential road bumps. At the very start of the week, a service sector activity gauge and credit spending report offer second tier figures, but it will be the RBNZ rate cut on Thursday that is the real threat.

US - The US economic docket looks to have just as much influence on our NZD/USD open orders as the New Zealand calendar will. There are no notable indicators due for release until next week, but the flow of data nonetheless picks up as the week wears on. Monday's leading indicators report for December will offer modest guidance for growth expectations. The following day brings the consumer confidence survey for January-an important reading since other sentiment gauges around the globe have started to perk up on lower gas prices and faith in government proposals for bailout packages and stimulus plans. Expectations for Wednesday's FOMC policy report are up in the air, but despite their inability to lower rates, the group still has to stimulate the economy. The top market mover for the week will be the United States' fourth quarter growth numbers. As the largest economy in the world, the health of this economy will define expectations for global trends. 

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By John Kicklighter, Currency Strategist, DailyFX.com

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