Talking Points:

• EUR/AUD’s Bullish Weekly Engulfing Pattern
• A Well-Defined Support Zone
• Clearly Favorable Trend Direction

The Australian dollar (AUD) was showing signs of weakness against most major currencies last week, while the euro (EUR) remained strong and resilient despite downside pressures. The price action result was a strong bullish engulfing candle on the EURAUD weekly chart.

Guest Commentary: Bullish Engulfing Pattern in EUR/AUD

An engulfing candle is considered a solid trading signal when the following criteria are met:

1. Price action of the most recent candle must fall lower and reach higher than the previous candle
2. The body of the candle to the right must make up at least 80% of the candle itself (small or no wicks are best). In other words, the open and closing prices must be close to the high and lows
3. The pattern must form on well-established support (for bullish set-ups) or resistance (for bearish set-ups)

This EURAUD set-up does, in fact, meet all of these criteria, so let’s take a closer look.

EUR/AUD Technical Analysis

Last week, the low was 1.4124 and the high was 1.4420. Add to this the opening price of 1.4143 and the closing price of 1.4397 and we end up with a very solid candle with very little wick on either end.

The previous week’s low was 1.4133 and the high was 1.4383, so by the numbers, last week’s price range fell nine pips lower and reached 23 pips higher than the week prior, while both weeks’ opening and closing prices were very close. This, in turn, created a candle that completely “engulfed” the previous candle.

Key EUR/AUD Support and Resistance Levels

The pair found support at 1.4130, a level that was once resistance and has caused reversals on both sides of the trading fence in the past. By looking back at EURUAD price action for the past three to five years, we can see that a bearish run was halted in the 1.4100 area from May 2010-October 2010 before falling further.

We saw several more touches of this price area in 2011 and again more recently in June of this year. Price managed to break and hold above 1.4100 in the middle of June before making a 2013 high at 1.5030, which is also an important support/resistance level.

Current price action now shows that we have turned the resistance into support at 1.4100 once more following last week’s clear rejection of lower prices.

Bullish Trend in EUR/AUD

Finally, we come to the third factor that makes this set-up so interesting. The EURAUD pair has been in an uptrend since as recently as March, but one could make the argument that the uptrend began in August 2012. For the purposes of this article, let’s look simply at the move that began the last week in March 2013.

The EURAUD price action last week shows a similar candle pattern to the last week in March. Price established support at 1.2300, and as of March 31, price had printed a candle that completely engulfed the previous week’s price action. This was a bullish signal which sparked a 2500-pip run higher.

From there, EURAUD found resistance at 1.5000, retraced to 1.4124, and then printed another bullish engulfing candle. Clearly, the trend is now established as being bullish, and we have a continuation set-up in the pattern we are discussing this week.

How to Trade This Set-up

Most traders will place an entry order 10-15 pips above last week’s high and place a stop loss 10-15 pips below last week’s low. In this case, that puts the long entry at 1.4430 -1.4435 and the stop loss at 1.4115-1.4110. This gives a total risk of 315 pips, meaning that in order to achieve at least 1:1 risk/reward on the trade, price must climb at least 315 pips after the trade triggers.

Looking at the chart again, we can see that price previously found resistance at 1.5000, so we have more than 315 pips to go before we hit resistance again. As a result, we can in fact set our first target at 1.4745 (1.4430 + 315). Set one order with these parameters and risk no more than 1% of capital.

Once the first target is achieved, we move the stop loss to breakeven plus ten pips (at least), and with no risk left to our account, we can hold the remaining lots for a second target.

That second target can be determined in one of three ways:

1. Add another 315 pips to the first target (1.4745 + 315 = 1.5060) for a 2:1 risk/reward and a total of 730 pips;
2. Use a previous resistance level as a target. In this case, since we have clear resistance at 1.5030 (the August 2013 high), we can use 1.5015 as a target, which will provide slightly less than 2:1 risk/reward. In either of these first two cases, place a second order, also for no more than 1% of total capital.
3. As the third option, since we have a solid uptrend established, and considering the last push higher was over 2500 pips, we could also look towards the next resistance level, which I have identified at 1.5450. Should you choose this option for the second target, it is wise to move your stop loss to the first target when price reaches the 1.5000 level, essentially locking in a guaranteed 1% should price not trade higher. Should you choose this option and the trade is successful, you should profit 315 pips/1% on the first target and 1020 pips/3% if 1.5450 is achieved. The total net for this scenario would be a stress-free 4% return on investment.

Since this is a weekly set-up, reaching the target will take time and won’t happen overnight, so traders should consider this more of an “investment-style” trade.

Risk for this trade, or any other for that matter, should not exceed 2% of your account balance.

By Colin Jessup, Guest Contributor, DailyFX.com