Trading Defensively with Holiday Trading Conditions and the Fiscal Cliff Ahead

This past week was an erratic one. The late-in-the-week shift in risk owing to the combination of a Fiscal Cliff miscue by the House of Representatives and natural risk unwind helped push the dollar higher and unwind some of the more extreme-positioned pairings.

The last 24 hours proved quite fortuitious for me as I was able to take partial or full profit on three separate trades. The first was an AUDUSD short position taken on the break of the 1.0500 former resistance as new support. I decided to book it at just under 53 pips shortly after the mild reaction to the S&P 500 futures collapse Friday morning in the Asian session. I left another 90 or so pips on the table, but my exposure to the 'risk' theme kept me exposed. I would also decided to cut loose my AUDJPY short from 88.10 for 43 pips before the weekend because I didn't want to run the risk of a gap in the thin conditions ahead.

My more progressive trade was the GBPUSD short from 1.6260 - played from the top of a long-term wedge and triple top formation. I dediced to book the first half for 100 pips on the sharp decline (the cable offered one of the biggest moves for the majors) and trail up the stop to breakeven plus 35 pips to ensure that this overall trade ends well in the green. In contrast to my two, booked Aussie trades; the GBPUSD doesn't risk carry, it is less sensitive to risk trends and is still well overbought. As such, I am comfortable carrying over this strong position.

In these three end-of-week trades alone, I made 2.8 percent return on my account by following the market conditions rather than just the technical setups or fundamental leans.

Moving forward, I will continue to trade defensively and make sure that any trades taken fit the pace of the market. There are, for example, plenty of pairs that would do very well if there were a strong risk aversion move. Yet I will be particularly demanding of momentum, correlations and fundamental encouragement in playing any of these setups. My two favorite risk setups are EURUSD should it break below 1.3150 and EURJPY if it drops below 110.50. Both are inherently overbought (the yen crosses particularly so), and a decline can come as a natural correction rather than a serious trend development. Other high-sensitivity risk trades are GBPJPY below 136, CADJPY below 84.50 and AUDJPY below 87.50; but it is important not to leverage up into the same theme. So choose which looks most over bought.

I also like to look for pairs that cater to alternative scenarios, so if there is to be a mild rebound in risk trends (a full blown advance would require a Fiscal Cliff resolution), I'll look at NZDUSD and NZDJPY (near 0.18150 and 69) since both have retreated further.

Two other pairs that can do well in a steady risk evironment because they are particularly over-extended and exposed to natural correction are EURNZD retreating from 1.6050 after an 8-day consecutive advance, and EURAUD from 1.2700 after a 10-day straight advance.

And, of course there are pairs that don't require risk trends to move. USDJPY has the yen sensitivity, but it can more easily use its balanced risk exposure to break 83.75 and retreat to more balanced levels. EURGBP breaking its wedge top above 0.8165, EURCHF retracing back to its floor and getting long at 1.2007, and AUDCAD clearing 1.0325 support are all good, non-risk setups.

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