How My Favorite Trade Sets Up: Euro Edition

I've written about my favorite trade setup a bunch of times here on the site. It's not necessarily the traditional technical pattern that gets me excited. It's when these patterns DON'T work out like the book says that gets me paying a little bit more attention.

'From False Moves Come Fast Moves', is the phrase that describes this trade the best. When everyone is leaning in one direction, the unwinding of that position creates a vacuum-like move in the opposite direction. In the case of a 'false breakdown', the combination of shorts covering, longs stopped out having to buy it back, and the natural buyers already there creates a vicious rip-your-face-off rally. The best part about this trade is that if the security rolls over again, all bets are off with minimal losses.

And this trade can work in both directions. A 'false breakout' traps longs above a key level and a quick crash in the security presents the opportunity for quick profits if you get short at the right time. Like the false breakdown setup, the risk is minimal because if the market gets back above those key levels, all bets are off. Again, the key here and best part of the trade setup is the risk management. The risk is these cases are minimal and well-defined, but if you're right you can expect a monster move that usually happens quickly.

Most of the time I'll post up the chart once the false move has already occurred (like this Gold example). But today I want to show you guys what I'm watching before a potential trading opportunity like this sets up. We're looking at the Euro right now. The best is when a security (stock, bond, currency, commodity, etc) is left for dead. In the case of $EURUSD, how many people can you count off the top of your head that believe the Euro trades higher from here? Since I can't think of many, this makes me look closer.

As you can see in this chart, $EURUSD made a new multi-year low last week getting headlines all over the place. What you won't read in the newspaper, magazine or see on TV or the internet is that as new lows were made in price, momentum is holding its own and hasn't confirmed those new lows. The potential for a bullish divergence is there:

The price I'm watching in $EURUSD is 1.2345 which was the closing low on Thursday May 31st. If it can manage to get back above those levels, all of the bears over the last week will get stuck below that key support and the squeeze is on.

OK, so we see the price action, we see the potential bullish divergence in momentum, what else? Let's go to the ETF and look at the volume. This is another hint that a fast move from a false move could be in the cards. $FXE is the Currency Shares Euro Trust ETF. Look at the huge volume as the Euro got crushed in late-may. Now notice how although we're currently at lower prices, the volume tells us that less selling is taking place. In other words, it appears that the sellers are exhausted and getting tired of selling.

From a momentum perspective, RSI is trying to put in the same bullish divergence that we saw in the $EURUSD chart above. So the price we're watching here for the ETF is around $123, which was the closing low for $FXE on May 31st.

Now here's the best part. We're JUST watching what's going on for now. Preparing ourselves for the possibility of a monster rally. And just because the potential is there doesn't mean that it will actually come to fruition. We may never put on the trade. But we like to have a game plan. And we want to be ready to rock and roll if the trade sets up like we want it.

So this is how I think as my favorite trade potentially sets up. I hope that you find it as interesting as I do. I seriously love this stuff.

Tags: $EURUSD $FXE $UUP $USDX