European political leaders meet this Thursday for the 19th time to discuss the continent’s on-going sovereign debt crisis. A resolution to the crisis has been elusive with the strategy of austerity tipping weak economies into severe recessions. The weaker European Union economies are asking for lessened austerity measures and likely won’t receive it. This strategy stand-off could lead to a risk sell-off.
In the event of risk sell off, the US Dollar stands to be the biggest beneficiary of Euro Summit indecision. Use the Donchian channel strategy to time entries and exits when buying the US Dollar.
Last week, twitter was lit up with polls about how 55% of Germans want to abandon the Euro and return to their own currency. Germans are becoming tired of bailing out other high spending countries and not receiving any confidence on a balanced budget in return.
Many economists have talked about how a Euro breakout will cost more for the Germans than a short term bailout. However, for now, Germany is stuck on demanding austerity from Greece, Spain, and Italy.
The problem is that Spain and Italy are so large they are too big to bail. The negotiations likely won’t resolve anything unless Spanish or Italian 10 year yields climb back above 7%.
This gives traders a set up for potential failure and uncertainty. Markets don’t like uncertainty and the US Dollar stands to benefit the most. Additionally, with the US Dollar spending most of June trading counter trend, we have a good opportunity for the trend to re-emerge towards Greenback strength.
Therefore, we will use the Donchian Channel Strategy as a means to establish entries and exits into selling the EURUSD. We can also use this strategy to buy the USDCAD. In both situations, we are buying the US Dollar. (You can apply the same methods to buying the USDCHF or selling the GBPUSD or AUDUSD.)
Rules of the Donchian Channel Strategy:
- Identify a strong trending market – as discussed above, I think the USD stands to be a strong beneficiary as a result of uncertainty in Europe.
- Add the Donchian Channel Indicator to a 2 hour price chart of your strong trending market. Input value is 55 periods.
- Filter your trades so that you are trading solely in the direction of the strong trend. Since the USD stands to benefit from this crisis, we will filter the trades to buy the USD. If we want to trade the Canadian Dollar (CAD), then we will buy the USDCAD. If we want to trade the Euro since it is the epicenter of the crisis, then we want to sell the EURUSD pair.
From this point forward, I will provide 2 separate rules. One set for buying in an uptrend. The second set for selling in a downtrend.
Buying Rules of the Donchian Channel Strategy:
4B. Place an entry order to buy 1 pip above the upper Donchian channel.
5B. Place a stop loss order at the lower Donchian channel. Manually trail your stop loss so that it follows the lower Donchian channel.
6B. Exit the trade when price reaches the lower Donchian channel. (If the stop loss is entered correctly, the trading platform will exit the trade automatically for you.)
(Created using FXCM’s Marketscope 2.0 charts)
Using the above rules, we can see that the upper channel of the USDCAD sits at 1.0318. Therefore, we will place an entry order to buy at 1.0319.
The lower Donchian channel rests at 1.0158 so we will place the stop loss at that same price.
If the trade doesn’t trigger, then we check out the charts tomorrow and move the entry and stop loss order to the new Strategic Price Point (SPP).
Shorting Rules of the Donchian Channel Strategy:
4S. Place an entry order to sell 1 pip below the lower Donchian channel.
5S. Place a stop loss order at the upper Donchian channel. Manually trail your stop loss so that it follows the upper Donchian channel.
6S. Exit the trade when price reaches the upper Donchian channel. (If the stop loss is entered correctly, the trading platform will exit the trade automatically for you.)
(Created using FXCM’s Marketscope 2.0 charts)
Using the above rules, we can see that the lower channel of the EURUSD sits at 1.2470. Therefore, we will place an entry order to sell at 1.2469.
The upper Donchian channel rests at 1.2742 so we will place the stop loss order at that same price.
There are several benefits to using a breakout strategy including:
- The Fear of the Unknown – We don’t know where prices are going so having a mechanical method to enter and exits while using entry orders helps to remove emotions from trading.
- Trading Volatile Markets – Successful traders will use breakouts during volatile markets. That way, the market is indicating to you when it is ready to trade to new levels.
Best of luck with your trading!
---Written by Jeremy Wagner, Lead Trading Instructor, DailyFX Education
To contact Jeremy, email jwagner@dailyfx.com. Follow me on Twitter at @JWagnerFXTrader.
To be added to Jeremy’s e-mail distribution list, send an email with the subject line “Distribution List” to jwagner@dailyfx.com.
The Donchian Channel Indicator is not a native indicator to FXCM’s Marketscope charts. To download the indicator, go here:
How to Install Custom Indicator
