This trade idea was first sent to subscribers of the Free Profitable Forex Newsletter on May 27 2022.
The EURUSD correction extended this week, with the pair now trading around the 1.07 level. It already traded above 1.0750, but got rejected there. This could already have been the high of the retracement, but for greater confirmation, we'll need to wait for the PCE inflation report later today (8:30 ET; 14:30 CET).
In our weekly Fx analysis this Monday, we highlighted the 1.07 - 1.08 zone as the key resistance for EURUSD. With the pair already trading here, it looks like the time has come to think about shorting again.
PCE inflation today could hint whether EURUSD retracement has ended or not
Still, we need to be careful in trading trend continuations. As is often the case with EURUSD retracements within a trend, the market has the habit of reaching one final high before reversing down. This is often a way that large market players (institutional traders, banks) use to clear the stops above a certain technical level and then take the other side of the trade. Though no one can tell with 100% certainty when and how it happens, these tactics often lead traders into traps and trying to trade fake breakouts.
Given the current situation, this final high could already have been reached as EURUSD got rejected from above 1.0750 this morning. However, a lot about where EURUSD trades in the near term will depend on the PCE inflation report from the US due in around 45 minutes. The PCE report is the key inflation metric that the Fed is watching and using for setting policy. So, there is potential for some market reaction depending on the deviation of the actual numbers versus expectations. EURUSD could even climb above 1.08 and thoroughly test levels there before eventually reversing lower and resuming the downtrend.
The consensus forecasts are looking for 6.6% headline and 4.9% core PCE prints. An upside surprise, even a modest one, could be enough to turn things around and provide the dollar with a new impetus to resume the bullish trend.
On the other hand, if PCE inflation comes in weaker, the dollar may extend another leg lower (i.e., EURUSD higher) as markets will start expecting the Fed to dial down hawkishness from the current aggressive stance. In this scenario, the USD correction could extend for a while longer, likely into next week, given the busy data calendar with the ISM index, Nonfarm payrolls, and other jobs data.
The technicals agree that EURUSD retracement should be in the final stages
The technicals are also starting to flash signs that the end of the retracement is near. Please have a look at the weekly analysis published on Monday, where we analyzed the daily chart. Below, we look at the short-term picture on the 4H timeframe.
Monitor the 55-day moving average. It has not been traded yet. A test above it and a move back below would perhaps be a solid bearish signal, as it would confirm that bullish sentiment has been clearly rejected from higher levels.
A break of the retracement channel (or flag) formation would be another confirmation that the retracement has ended. Currently, its support line is located right around the 1.07 level (see chart below).
Overall, the high of this retracement shouldn't be far. EURUSD has reached the key 1.07 - 1.08 resistance, and it will be a tough nut to crack. It's unlikely that EURUSD will be able to break sustainably higher without a major improvement in the Russia-Ukraine war and the gas/energy crisis in Europe. Both are still looking unlikely.
Finally, it's also worth a reminder that May is seasonally a bullish month for the US dollar. At current levels, EURUSD needs to fall toward 1.05 for the USD to end at least modestly stronger on the month and fall in line with its seasonal pattern. On balance, it's good to have seasonality as a tailwind for a trade, and with the dollar now having corrected, the last trading days of May could be when it resumes its gains to finish May on a strong note.
- Watch the retracement channel formation on the 4H chart. A bearish break of this channel would provide "good" confirmation that the trend is ready to resume.
- Alternatively, if EURUSD makes another attempt higher (perhaps if PCE inflation surprises lower), then you can look to go short at higher levels (could be closer to 1.08 in this case).
- Above the bearish entry pattern;
- the stop shouldn't be much higher than 1.08, but that will also depend on how exactly things develop from here;
- EURUSD could make a brief test, perhaps as high as 1.0850. In such a case, the stop may need to be placed above such an important rejected high.
- 1st - 1.05
- 2nd - 1.0350 lows
Trade signals from the past weeks
- May 16, Long EURGBP from 0.8490, in progress (trade idea sent May 11, 2022)
TOTAL P/L in the past week: 0 pips
TOTAL: +5410 pips profit since October 1, 2018