"Dollar hits 1½-year high against euro," reported the Financial Times on October 21, after the EURUSD slid below $1.32. But it didn't stop there. By 9 PM, the euro-dollar exchange rate fell to $1.30, clinching the dollar's staggering 30-cent gain in just three months. (Ed. -- On October 27, the EURUSD fell even lower, to $1.23.)
Why is the dollar gaining? Apparently, hedge funds were "returning to cash in anticipation of massive investor withdrawals." Plus, said analysts, Ben Bernanke's new proposal for another U.S. economic stimulus package added optimism to the dollar's future.
Every time I read reports like these, I think of how well they explain the market action – and yet how utterly useless they are for a forex trader. Let me ask you a question: If tomorrow you see another report of the Fed's new initiative, or of hedge funds selling assets, should you expect the dollar to gain again?
The answer, of course, is no. If you've been watching forex markets long enough, you know from experience that similar news reports tomorrow can "cause" the opposite reaction in the EURUSD – or no reaction at all. It all depends on how forex traders interpret tomorrow's news. So, the real question then is – what determines their interpretation?
According to the Elliott Wave Principle, how traders see the news depends on their collective mood. If they feel optimistic towards the USD, they will interpret almost any news report as bullish. If, on the other hand, their collective perception is depressed, their interpretation of the news will be negative – and so will be their trading decisions regarding the dollar.
That's the real value of the Elliott wave approach – it allows you to predict market participants' collective reactions ahead of time. All you need to do is look for Elliott wave patterns in market charts, identify them – and then forecast which part of the pattern comes next.
On Monday evening (Oct. 20) – before the EURUSD slid to the new lows – the Daily Forecast page of Elliott Wave International's Currency Specialty Service posted this chart and forecast for subscribers:
Update For: Tuesday
Posted On: Mon, 20 Oct 2008 19:45:00 GMT
EURUSD [Last Price]: 1.3324
[Lower, into a bottom] The euro is on its way to a new low beneath 1.3261.
That forecast was not based on the news. It was based on the fact that, as you can see in the chart above, the EURUSD had formed what Elliotticians call a "triangle" (circled in red). Triangles always resolve in the direction of the preceding trend – which, in this case, had been down. That's it! Simple and effective – and no need for "interpretations."
Now that the EURUSD has fallen this far, some forecasters say it will drop as low as $1.26. But the same October 20 Currency Specialty Service forecast added: "Thrusts from triangles are terminal, so once a new low is registered we'll start looking for evidence of a bottom…"
So don't be surprised if, once the EURUSD finds that expected bottom, no matter how "bullish" the news may get for the buck, it may find it difficult to maintain its recent winning streak.