Five things to know about trading the EUR/USD
Among the most popular forex markets is the EUR/USD pair, which connects two of the world's biggest economies. In this article, we'll take a closer look at the popularity of EUR/USD, and explore some of the significant drivers that move the pair’s pricing.
1. What is the appeal of the EUR/USD?
The euro and U.S. dollar (EUR/USD) major currency pair is, at any given moment, often the most-traded market in the entire world. Representing two of our most powerful and influential economies, it offers traders a huge range of trading opportunities. Trillions are traded on it every single day.
Partially because of this, the EUR/USD is one of the most liquid currency pairs and is frequently volatile. The pair’s large trading volumes mean greater liquidity (and sometimes greater volatility) than almost any other financial markets can boast. This wealth of opportunities makes it a popular choice for forex traders.
Various factors drive EUR/USD exchange rate movements, and understanding them can provide valuable insight into potential directions for the pair in future trading sessions. Trading the EUR/USD can potentially reap great rewards - but can also lead to sizable losses - so knowing your stuff around this pair is essential.
2. Historical analysis of the EUR/USD
The EUR/USD has been a major currency pair since the introduction of the common currency 1999. Since then, several events have had a significant impact on its exchange rate:
- The introduction of the euro as a unified currency in 2002 was a major event that, alongside other market factors, increased the euro’s value.
- In 2008, the EUR/USD experienced a massive drop in its value due to the global financial crisis.
- On 6 May 2010, a "Flash Crash" in equities occurred, when a combination of an algorithmic trading systems glitch and high-frequency traders sent the EUR/USD plunging almost 1000 pips in minutes.
- From 2014 to 2016, the pair was relatively stable, hovering between 1.05 and 1.15.
- In 2016, the pair experienced a significant drop after the turmoil of the Brexit referendum and Trump being elected US president, falling to below 1.06 toward the end of November.
- In 2017, the pair rose to a high of 1.20, driven largely by a weaker US dollar.
- From 2018 to 2020, the pair was once again relatively stable, hovering between 1.10 and 1.15.
- In 2020, the pair saw significant volatility due to the COVID-19 pandemic, dropping to below parity at around 0.95.
3. Fundamental factors driving the EUR/USD pair
The EUR/USD currency pair is the most actively traded forex market in the world and is often used as a barometer of global risk sentiment. As such, it is important to know how to identify key drivers of the EUR/USD exchange rate. Fundamental analysis - i.e. studying economic indicators to identify potential trading opportunities - can provide valuable insight into what will move this currency pair in the short and long term.
There are several macroeconomic events that can drive the EUR/USD exchange rate, including changes in interest rates, economic growth, employment data, inflation, balance of payments, and political risk.
Political and economic factors: Politics, such as trade relations between European Union countries and the US, also have a major impact on EUR/USD exchange rate movements. The euro is particularly sensitive to news about European Union domestic politics, after-effects of the UK's Brexit and the economic performance of various EU nations. Likewise, news events out of the U.S. like employment numbers and GDP growth statistics, along with political developments such as elections and trade wars, can affect the dollar’s value against other currencies like the euro.
Interest rate differentials: Central Banks' interest rate differentials and any changes to monetary policy play an important role in driving changes in the EUR/USD exchange rate. This occurs when the European Central Bank (ECB) and U.S. Federal Reserve (the Fed) set their respective benchmark rates, which can have a significant impact on currency values.
Big news: The lead up to major economic events like America's nonfarm payrolls or the latest ECB or Fed meeting, can cause increased interest in the EUR/USD pair and, with that, more liquidity and volatility. Even more influential can be extreme news from sudden, unexpected sources - for example a terrorist attack or a natural disaster in either the United States or Europe. As such, it's vital for fundamental analysis enthusiasts to keep up-to-date economic calendars of when all the biggest announcements are, such as Fed and ECB meetings and nonfarm payrolls.
Facts and figures: Macroeconomic announcements of key data such as GDP figures, the latest unemployment data, PMI readings or monetary policy announcements can also lead to substantial market movements. Meanwhile, news related to trade deals and other geopolitical matters should also be monitored closely for potential impacts on prices.
4. Technical analysis and the EUR/USD
Technical analysis is an important tool for EUR/USD trading. It involves studying past price movements to identify potential trends and predict future market direction.
- Price chart: One of the most commonly used technical analysis tools is the price chart. Price charts display historical prices over a specified time frame and allow traders to spot trends or patterns which may indicate potential opportunities for trade. Patterns such as head and shoulders, double tops and bottoms are all useful in helping traders identify opportunities in the pair.
- Oscillators: One of the most commonly used technical indicators, oscillators are charted against price movements in order to track changes in momentum and generate buy or sell signals. Oscillators such as Relative Strength Index (RSI), Moving Average Convergence Divergence (MAC), Commodity Channel Index (CCI) and Stochastics can be used to identify overbought and oversold levels in the market.
- Trend lines: These are lines connecting two or more lows or highs in a currency pair, to identify the overall trend. They can be used to spot emerging trends in the EUR/USD currency pair. A rising trendline would indicate an uptrend, while a falling trendline is representative of a downtrend. A break above or below the trendline could signal a possible shift in trend direction and should be closely monitored.
- Average daily range: It's also important to be aware of the level of volatility in the EUR/USD pair. High levels of volatility mean quick price movements, which can present opportunities to both make and lose profit. It is useful to consider the pair's average daily range (ADR) as per its chart to try and gauge its level of volatility, and use stop-loss and take-profit orders when entering trades.
5. Risk management and trading strategies
Risk management is essential for any successful trader when trading the EUR/USD currency pair. This involves controlling your risk exposure and doing everything in your power to limit your potential losses and also to safeguard your possible profits.
- You can place stop-loss levels when you open a EUR/USD position to limit losses if a trade moves against you.
- Meanwhile, take-profit levels may also be used to lock in profits as soon as you're 'in the money'.
- In addition to these, ensure that you practice proper money management, which means not risking more than a predetermined amount of capital on each trade.
- It’s also important to consider developing a suitable trading plan for the EUR/USD pair - this could involve using technical analysis tools such as those outlined above - and then sticking to it. Doing this with discipline and emotional control will help ensure consistency in your trading strategy and potentially achieve better results for you.
6. Final thoughts
The EUR/USD pair is one of, if not the most, popular major currency pairs traded in the currency markets. It offers traders an array of opportunities due to its liquidity and volatility, and understanding the key drivers that move it can help you make informed decisions when it comes to trading.
Historical analysis shows that major events such as the introduction of the euro and major crashes in the EUR/USD pair have rocked the entire world. Likewise, fundamental analysis shows how rate decisions taken by central banks, geopolitical developments and economic outlook have all had a significant impact on the exchange rate of this major currency pair. Lastly, technical analysis of the pair's chart patterns is also a key component in understanding the drivers of the support and resistance levels and other trend-indicating tells of the pair.
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