Failed Expectations about AUD/USD and USD/JPY

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Well, here we are. The Reserve Bank of Australia has cut interest rates to a record low level of 1.5%.

With the AUD in the lows and heading into the release in a weak USD environment, the economists and the pre-release market seemed to ‘get it right.’

But other than an immediate post-decision headline spike down, the Aussie rallied basically vertical for the day’s three trading sessions. Yes, the currency RALLIED on a rate cut.

Why, you might ask? That’s not what the textbooks say is meant to happen? When you cut interest rates, investors are meant to be discouraged from holding the currency in question, therefore selling and making price go down.

But the realities of market dynamics for fundamental Forex traders aren’t as simple as following a macroeconomic textbook of when to buy and when to sell. Exactly the same that being a successful Forex trader isn’t about being right or wrong on whether they think a central bank will press the red or green button when it comes to interest rate decisions.

Successful Fundamental Forex trading, especially in the retail trading environment that we find ourselves in, is about identifying where the market expectations lie and then trying to take advantage of the subsequent re-pricing if the realities do not actually align.

“There are no prizes for being right or wrong on a central bank call and just because you side with consensus and get it right, doesn’t mean the market will give your trade the strong directional move you’re looking for.”

This is why yesterday’s RBA Preview blog wasn’t just about about whether we thought the RBA would cut interest rates or not. It was actually about finding trading opportunities from misplaced market expectations.

Our thinking heading into the RBA decision was as follows:

So putting this all together, we have an expectantly bearish market going into a live RBA meeting where the ‘shock’ will be a no change to interest rates. That says to me that the greatest risk of disappointment lies with AUD/USD shorts. No matter what the RBA does, the sensible trade from a risk:reward point of view is more likely long AUD/USD.

Yes, playing from the long side on an interest rate cut may seem crazy on the surface, but when interest rate futures markets are pricing in a 2 in 3 chance that the RBA cuts and the Aussie Dollar has been hammered off its highs in expectation of a cut, expectations were extremely stretched to the one side.

You haven’t been building your yearly Aussie Dollar position for months. Your trading algo hasn’t been taking ticks on price mismatches. You’re a retail trader who in the grand scheme of things has come late to the party and just wants to get paid!

Expectations have been getting priced in for weeks so it’s not about taking a news punt. An ECN Forex broker like Vantage FX can’t guarantee you a price and blindly hitting buy/sell as news is released isn’t like hitting the bid/offer on a futures ladder. You are going to get slipped and if a broker tells you that you aren’t, then it is so often too good to be true. So identify your levels, and play the fallout.

Take a look at some of the following charts we’ve been sharing on the @VantageFX Twitter account, taking note of how long after the initial news move that it takes to fully re-price the misplaced expectations:

AUD/USD hourly

AUD/USD 1 hour

EUR/AUD 4 hours

EUR/AUD 4 hour

USD/JPY daily

USD/JPY daily

We hope this slightly out of the box way of thinking about fundamental trading is a help.

Safe trading!

This Wednesday

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This is a guest post originally appeared on Vantage FX. Reposted with permission.

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