The Right Way to Trade EUR/USD Here

08/10/2011 7:00 am EST

Focus: FOREX

Anticipating a break of support, a EUR/USD short play is prudent here, and traders can enjoy the benefits of clearly defined entry and profit targets, as well as protection if the pair reverses higher.

Volatility is on the rise in stocks as the economic outlook is questioned on the heels of a US debt downgrade. EUR/USD volatility is surpassing levels not seen since June 2010, and when the market gets as volatile as we have seen lately, one way to trade it is with a breakout type of strategy.

The Mechanics of a Breakout

Analyze a chart and determine the mood of the market, or trend direction. In the case of the EUR/USD, the risk aversion has been contagious lately. Additionally, after finding support at the 200-day simple moving average (SMA), prices have failed to create a higher high. Therefore, we will look for and filter for sell trades.

In a selling opportunity, identify levels of support and anticipate a break below support. In a buying market, identify levels of resistance and anticipate a break above resistance.

Since we are filtering for sell trades, we are going to identify support and place a trade based on a breakdown through support.

chart
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The benefit of breakout trades is that they do not require any indicators on your chart. Take a clean chart and identify levels of support. I have included the 200-day SMA (blue line), as that is often used by large institutions as a level of support.

Horizontal support rests at the low of Friday’s candle (1.4055). Additionally, the 200-day SMA is nearby at 1.3940. This congestion zone of 1.3940-1.4055 will likely provide, at a minimum, temporary support for prices should they fall further.

NEXT: Where to Enter and Take Profits on This Trade

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The Entry and Stop Loss

chart
Click to Enlarge

Place an entry order to sell one pip below the support level, or at 1.3940.

When identifying our stop placement, scale down to a smaller time frame chart (between one-hour and four-hour time frame). Place the stop loss just above the swing high in this case because we are creating a sell entry order.

Now, take twice the distance of your stop loss and project that from your entry point for a take-profit level.

One of the important rules of trade management we discuss inside the DailyFX Webinars is risking less than 5% of your account on all open trades.

See related: Make Sure Risk/Reward Is on Your Side

The benefit of a breakout type of strategy is that we can be wrong on the trading idea, meaning the price of the EUR/USD can move straight higher from here, yet we miss out on a losing trade.

As a trader, not only do I want to enter into winning trades, but I also want to be kept out of losing trades. A breakout style of trading can help navigate volatile waters and keep you out of some losing trades.

By Jeremy Wagner, lead trading instructor, DailyFX.com

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