Fundamental analysts look at forex markets the way they look at physics: For every action, there is a predictable, linear, immediate reaction -- i.e., bullish news for the euro (or dollar) makes it rally, and bearish news makes it fall. Simple.
Well, this week we've seen two perfectly euro-bullish news stories; both had to do with China. On Tuesday, December 21, Chinese Vice Premier Wang Qishan said that, "China has taken steps to help European nations combat the sovereign debt crisis." (AP)
After these comments the euro rallied against the U.S. dollar. As one forex analyst put it, “the comments implied that China may increase its purchase of euro-zone debts in the nation’s foreign reserves.”
That seems to make sense. China has vast U.S. dollar reserves, so if they start spending them on euro zone debt and flood the market with dollars, the dollar must fall. A perfect backdrop for the EUR/USD rally on December 21.
Yes, except for the fact that after rallying barely 80 pips, the euro reversed that very day. It gave back all the gains, and then some.
OK, so maybe the forex markets didn't quite "hear" what China said. So on Thursday, December 23, China's foreign ministry spokeswoman Jiang Yu publicly "reaffirmed its pledge to support troubled European nations to overcome the debt crisis."
Result? No euro rally. This intraday chart from Elliott Wave International's Currency Specialty Service summarizes the EUR/USD action since December 21 best:
As you can see, the pair has drifted lower all week, with the U.S. dollar taking the upper hand. How can forex markets so brazenly dismiss the logic of "fundamentals"?
They do that because forex markets are not rational or logical. It's not enough for a news story to emerge -- forex traders must also believe it. And our beliefs, by definition, don't need logic. That's where it crosses into the territory of collective psychology, and that's why "fundamentals" are not enough when forecasting a currency trend -- you must also take into account the emotional bias of market participants.
Elliott wave analysis can help you do that. On Monday, December 20, one day before China announced its support for the euro zone, EWI's intensive Currency Specialty Service posted this bearish EUR/USD forecast:
Update For: Tuesday [December 21]
Posted On: Mon, 20 Dec 2010 22:28:07 GMT
EURUSD Last Price: 1.3120
[Lower] Key Levels: 1.3360.The euro weakened Monday, showing no sign that the larger decline is complete. Further weakness lies ahead.
Elliott wave analysis works by identifying one or more of the 13 known Elliott wave patterns in market charts. The patterns reflect market players' emotional bias, helping you make a probability-based forecast for where prices should go next. No news, no guessing about the impact of the "fundamentals."