Top Trade Idea For April 7th, 2014 – AUD/USD

AUDUSD Upside on the Horizon

Given the spotlight that’s been placed on risk sentiment, AUDUSD is set up to provide us with a great opportunity.

The Background

On the fundamental side, we’ve seen the dissipation of concerns in 3 ways: Russia-Ukraine tensions have blown over; China issues are being suppressed and losing their fear status (at least for now); and the RBA has been comfortable with AUD’s recent pricing and sees no need to lower rates in the foreseeable future.

The first two factors are relevant in that they affect broad risk appetite and global growth prospects. With those worries out of the way, money is free to gravitate towards risk assets (like AUD as a commodity currency). Most important is the latter factor as the RBA holds tremendous power in affecting the Australian dollar exchange rate.

Money gets put where the central bank’s mouth is.

 

This most recent ‘neutrality’ coming from the RBA has kept AUDUSD well-bid—since many players were operating under the base-case assumption that the RBA would be leaning towards lowering rates and desiring a weaker AUD—and supports the case for a long position in the pair. This sentiment shift has been strong enough to push this currency past a very notable long-term upper trendline.

Also note that prices solidly held above this trendline after the break.

Technical players typically maintain a keen eye on price action around major levels like this and upon seeing a “clean break” of the level, many technical participants will be excited to initiate new long positions. This motivation will be especially powerful given the lack of additional major resistance levels in front of an upside move.

Taken together, the strong upside bias from both a macroeconomic and technical perspective make for a potentially lucrative trade opportunity on the long side. But as always, success will come down to entering at a favorable level with an intelligent target and a stop loss that offers us a healthy reward to risk ratio. So let’s dig into some charts and data from the past couple of weeks and hash out these details.

The Opportunity

AUDUSD finished last week with a strong rally on Friday. Before going any further it’s important to understand the short-term positioning to get an idea of whether that rally was from shorts getting forced out or fresh longs joining the party and the consequent implications. We can get a good idea on that by looking at the latest futures contract positioning data:

In a single day we saw over a 5% increase in Open Interest (the total number of open futures contracts for the Australian Dollar). From this we can infer that the latest move was caused by market participants opening up new long trades (and not simply old, stale short traders exiting).

Why does this matter? Well, with longs getting a bit crowded in this trade in the short-term, there’s a higher chance of some of them being trapped and forced to exit, pushing price lower, which will allow us a better entry opportunity. Look to get in near the clear bottom trendline pictured on the hourly chart below, putting your opening price around .9220-.9335.

Your first upside take profit from there will be the cluster of stops from people on the other side of your trade. The orange box on the chart is that area where shorts have stops aggregating together for you to exit your winner, right around the .9310-.9315 area.

If you’d only like to take partial profits there or wait for a higher move altogether, set your sights on getting out just below the protective selling ahead of the barrier option at .9350.

A stop below .9200 would offer an excellent reward to risk ratio as you’d only be out 25-40 pips while your take profit would be at least 80 pips and as many as 120. If price does end up dropping below .9200, it’s time to get out for now anyway because the trade idea has been invalidated.

In review, these are the key points:

General risk conditions support AUD
RBA stance keeping AUD strong
Long-term technicals to inspire more AUD longs on top of all that
Look to enter as price approaches the clear hourly trend line near .9220
The first target is a cluster of stops from market participants who are short, just above .9310
Your second target would be just below the barrier option’s protective selling, around .9340

Stay safe out there and good luck!