High Risk and High Reward in the EUR/GBP Range Setup

02/13/2009 11:16 am EST

Focus: FOREX

There is a high breakout risk from EUR/GBP over the next 24 hours as technical volatility meets the highly unstable, fourth quarter GDP numbers from Europe. However, the potential for data to meet or exceed recession forecasts could actually work in favor of the pair’s strong, technical range.

Why Would EUR/GBP Hold a Range?

Levels to Watch:

Range Top: 0.9075 (Fib, Pivot, Trend, SMA)
Range Bottom: 0.8630 (Fib, SMA)

Not only has the EUR/GBP seen substantial volatility recently through its connection to general risk trends and fundamental shifts, but this pair will have to deal with substantial event risk over the next 24 hours. The first readings on euro zone and German GDP are scheduled to hit the wires three hours apart for Friday’s European session. With the BOE governor saying the UK is facing its worst recession since WWII, the European data will have a lot of leverage.

The EUR/GBP is facing just as much risk from a technical standpoint as it is from the fundamental side. A massive rally over the past three sessions has firmly set momentum behind the bulls. This puts considerable pressure on resistance built around 0.9050/100 through a series of daily highs, the 20-day SMA, and 50% Fib retracement of the last bear wave.

Suggested Strategy

Long: Half size (or smaller) entry orders will be placed at 0.9050–a relatively aggressive level.  

Stop: An initial stop at 0.9140 is relatively tight to account for the high breakout potential. To secure profit, move the stop on the second lot to break even when the first target hits.

Target: The first objective equals risk (90) at 0.8960. The second objective is 0.8780.

Trading Tip–There is a high breakout risk from EUR/GBP over the next 24 hours as technical volatility meets the highly unstable, fourth quarter GDP numbers from Europe. However, the potential for data to meet or exceed recession forecasts could actually work in favor of the pair’s strong, technical range. Looking at the technical and fundamental influences playing on this pair, it is clear that this is a setup only for those that are risk tolerant and working with a sound strategy. The German and euro zone growth numbers have considerable market-moving potential as they are the first readings, and speculators are taking a greater interest in growth to forecast which economy will be the first to recover from its slump. The market will have to be disappointed by the data (whether or not an inline reading will be enough is uncertain), as momentum is in the bulls’ court and the BOE governor has laid out a forecast for a severe recession. Avoiding this trade altogether is the best policy for those who are cautious. However, even for the risk takers among us, they should be prepared with a strategy that uses relatively tight stop (but not too tight, as volatility could produce a significant tail after the release), close targets, and a reduced position size. We recommend using half or a quarter of the size of normal lot size with this strategy. What’s more, we will be prepared to cancel open orders should spot hit 0.8950 before we are entered or before Friday’s close.

Event Risk: Euro Zone and UK

Euro zone – There is substantial event risk on the European economic dockets over the next 24 hours and beyond. To fully understand the impact this collective data may have on price action, we have to consider the general fundamental interest behind the euro over the past weeks and months. In this period, speculation has wavered on the region’s economic health (compared to its major counterparts) and what it means for potential returns on European assets going forward. After the ECB announced it was holding rates unchanged this month, traders took this as a sign that perhaps the economy would see a recovery before the US and other comparable investment centers—and with a benchmark yield that holds a considerable advantage on the international market. Considering this growth benchmarking, there will be a sure focus on the GDP numbers. Expectations of annual contractions between 1.1 to 1.4 percent are modest, and leave a lot of room for surprise. Looking beyond the weekend, more timely PMI data will already set up 1Q data.

UK – Bank of England governor Mervyn King has already set the tone for fundamental pound traders. Projections for the worst economic slump in decades from what is supposed to be a conservative figurehead have lowered the yardstick for speculators. From here on out, all data releases will have to fight a bearish current. Starting directly after the weekend, we will dive back into the worst-hit sector in the economy so far—housing. Expectations for volatility after the CPI data and BOE minutes should be restrained. Rates are already expected to reach zero, and the quarterly inflation report has already covered everything. Retail sales still holds some clout. 

By John Kicklighter, currency strategist, DailyFX.com

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