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This paper models external merchandise trade in the Palestinian Territories (West Bank and Gaza Strip) for the period 1968-1998. It gives an empirical evidence for this modeling. It provides an analysis for trade by using cointegration analysis and by estimating a vector error correction model. The cointegration analysis, mainly, suggests that only domestic demand and Jordanian demand are the significant determinants of Palestinian trade in the long- run, in addition to the existence of trade with the rest of world. On the other hand, the short-run results imply domestic demand and Israeli demand are two factors determining Palestinian trade in the short-run, under the prevailing imposed customs union with Israel. One common feature of both Dynamic cointegrating analysis and OLS estimation results is that Palestinian trade affected significantly, with a negative sign by growth of domestic demand. By using OLS estimation it investigates the instability of trade over study period. Both Chow's break point tests and CUSUM and CUSUMSQ tests results support the instability hypothesis for trade equation.