Two of the most traded currencies in the world are the US Dollar and the Euro. Naturally, this is the main reason that most forex traders tend to trade this currency. Yet, how to trade EURUSD effectively?
This is of course quite an open ended question as there are so many ways in which a forex trader can make a profit on this pair. They could use fundamental analysis, technical analysis or a combination of both.
This is because EURUSD is driven by a number of factors. These include economic indicators coming out of the Eurozone or indicators coming out of the USA. It is also one of go-to trades in times of general market risk sentiment adjustments.
Given the extensive volume that is traded on the EURUSD it is also one of the best pairs to trade using technical analysis. This is because technical analysis is based on behavioural finance theories.
Fundamental EURUSD Trading
When trading forex and options with fundamenal analysis, you have to have a vague understanding of what fundamental analysis means in the context of currencies and more particularly, the Dollar and Euro.
Fundamentals are those factors that should impact on the theoretical long term value of the currency. These are factors such as interest rates, inflation, Balance of payments, Economic growth etc. When these change, they impact on the demand that traders have for holding that currency.
Hence, for the EURUSD forex trader, monitoring Economic data releases is important to see whether there will be any “price action” impact on the release of the data. Below we will take a look at some of the most notable economic indicators and how to trade them as an example.
Non Farm Payrolls (NFP)
Perhaps one of the most notable indicators around the world, the NFP is followed by traders worldwide. It is a measure of how many jobs have been added in the USA. Hence, it is often seen as one of the most important barometers of the economic growth.
The way the market reacts to the announcement of the NFP depends on what it had been expecting prior to the announcement. If the number is broadly in line with expectations then there will not be significant volatility.
However, if the market was expecting a completely different number then there is definitely bound to be some market volatility and especially in the EURUSD. This is because all traders are changing their view of how the Fed will respond to the announcement.
If the NFP is much stronger than was expected, then demand will increase for US dollars and the EURUSD price will decrease.
Conversely, if the number is much lower than expected then the impact will be that demand for the US dollar will fall and EURUSD will increase. Of course, this is all assuming that there are no changes in to Eurozone economic data.
On the EUR side of the currency trade, the best barometer of economic growth is the Eurozone GDP. Given that the Eurozone is comprised of a number of countries, these growth numbers are specific to each country.
However, those that have the most important impact on general Eurozone growth are Germany and France. These are the largest economies in the Eurozone.
In a similar fashion to how the trader could exploit movements on the US dollar with the NFP, EURUSD traders will do the same with the expectation and realisation of Eurozone growth numbers.
EU/US Interest Rates
Interest rates also have a large impact on the demand for a particular currency. This is because the greater the interest rate, the more return an investor will gain for holding that currency. So generally an increase in the interest rate will lead to an increase in the demand for the currency.
On the other side, lower interest rates lead to less demand to hold that currency. Hence, traders can trade the fundamentals around the ECB and Fed interest rate announcements.
In fact, trading ECB and Feb announcements can be one of the most interesting and volatile. This is because it is not a piece of data that is printed but rather a press conference.
Traders are always trying to anticipate what the decision will be based on what is currently being said in the announcement. Some traders even try to look for cues in the form of the tone of the language etc.
Hence, for all EURUSD traders who want to make the most of volatility surrounding these announcements, trading in this time is essential to success.
Another important indicator is the inflation rate. The inflation rate that traders usually tend to follow is the Consumer Price Inflation (CPI) but there are other indicators such as the PPI and core inflation.
Inflation is important because it has an ancillary impact on interest rates. Inflation changes the view of the ECB and Fed about price increases in their country.
Central bankers like Draghi and Yellen will try to slow down price inflation by adjusting interest rates. Generally, if they want to try and slow the inflation down they will increase interest rates.
This means that EURUSD traders will try and adjust their positions if they have a view that the banker will change the interest rate in the next meeting.
Similarly to the way that they would trade GDP numbers or NFP numbers, the traders will take a look at market expectations and how this differs from the number printed.
In the Eurozone, CPI data is different for each country but most traders tend to watch those coming from Germany, the economic powerhouse.
EURUSD Technical Trading
Technical analysis is mostly based on studying charts, patterns and trading indicators. It is a tool used to forecast how an asset will move in the future based on how it has performed in the past.
Technical analysis traders are of the view that other traders also follow the trends and hence will impact the price of the currency pair in a positive feedback loop.
It is also important to note that if the EURUSD forex trader wants to use technical analysis, it makes more sense to do so when it is most liquid such as in the European or US trading hours.
There are numerous technical analysis tools including candlestick analysis, trends, volume and chart patterns. We will take a look at some of the most important as they apply to the EURUSD pair.
Moving Averages and Momentum
One of the most important assumptions behind technical analysis is that momentum tends to continue. If EURUSD is trending in one direction, it is more likely than not to continue doing so.
Hence, traders will look at such indicators as the moving averages which allow the trader to get an idea of the underlying trend on the currency.
Some traders will indeed conduct more analysis on the moving average trends and take a look at the MACD indicator or Money Flow indicators.
We have previously looked at a number of option strategies including bollinger band strategies.
Some technical traders spend alot of time studying the EURUSD charts to spot some tell-tale patterns or formations. Sometimes when a pattern is formed, the trader can estimate the levels the pair will eventually trade.
These include such formations such as the Head and Shoulders, the flag, the triple bottom and the double top.
The EURUSD pair is well suited to using chart formations. This is because it usually requires an asset that has a lot of trading volume behind it.
Choose a Broker
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