Forex Trading: Why You Need to Look Past Fiscal Cliffs

The "fiscal cliff" agreement did not set the course for EUR/USD -- here is why.

By Elliott Wave International

First, a word on how we all are conditioned to think that, "momentum will remain constant unless acted on by an outside force." Read this excerpt from Robert Prechter's May 2004 Elliott Wave Theorist:

"...'Momentum will remain constant unless acted on by an outside force.' This mode of thought is deeply embedded in our minds because it has tremendous evolutionary advantages. When Og threw a rock at Ugg back in the cave days, Ugg ducked. He ducked not necessarily because his mind had inherited and/or learned the consequences of the Law of Conservation of Momentum.

"The rock would not veer off course because there was nothing between the two men to act upon it, and rocks do not have minds of their own.

"Earlier animals that incorporated responses to the laws of physics lived; those that didn't died, and their genes were weeded out of the gene pool. The Law of Conservation of Momentum makes possible our modern technological world. People rely on it every day.

"Despite its use in so many areas, however, it is inapplicable to predicting [the financial markets]..."

Why did Prechter postulate that following this fundamental law of physics does not help you trade better? Here's a fresh example; see for yourself.

Hours before the December 31 deadline, U.S. lawmakers reached an agreement to avoid the "fiscal cliff." When trading resumed on January 2, most markets around the world opened higher. EUR/USD, the world's biggest forex market, also rose. Said one January 2 headline:

"Yen, Dollar Weaken as US Budget Accord Damps Demand for Refuge"

In other words, the "rock" was thrown: The "fiscal cliff" deal was reached, which "increased the demand for riskier assets," such as the euro, and dampened the demand for "safe assets" like the U.S. dollar. Now, unless some "outside force" were to act on the momentum of this important event, EUR/USD should have kept moving higher. But it didn't.

After jumping as high as 1.3295 in overnight trading on January 1, by mid-day on January 2 EUR/USD erased all of the gains. Take a look:

What happened? What "outside force" veered the "rock" off its course?

Well, none, really. Sure, pundits can rationalize now, after the fact, what details in the "fiscal cliff" deal may have changed the minds of forex traders. But the fact remains that, as EUR/USD was rising, nothing was suggesting that the "rock" would soon stop its ascent -- and fall.

Here's where Elliott wave analysis gives you an edge. With Elliott, you don't rely on the news stories ("outside forces") that almost everyone else uses to forecast the markets ("the rocks").

Instead, you study Elliott wave patterns in market charts. Every rally and decline reflects the decisions -- and emotions -- of the traders. Study that instead, and you'll soon realize that, more often than not, the markets tip their hands before the news is ever announced.

For example, our Currency Specialty Service analysts did not know that the "fiscal cliff" would be averted. And they didn't need to, because Elliott wave patterns in EUR/USD were already bullish:

EURUSD (Intraday)
Posted On: Dec 31 2012
11:13PM ET / Jan 1 2013 4:13AM GMT
Last Price: 1.3200
[Consolidating before higher] Prints above 1.3286, the 'b' wave high, would begin to favor a thrust from a fourth wave triangle going forward.

Now, that's a real, tangible advantage.

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This article was syndicated by Elliott Wave International and was originally published under the headline Forex Trading: Why You Need to Look Past "Fiscal Cliffs". EWI is the world's largest market forecasting firm. Its staff of full-time analysts led by Chartered Market Technician Robert Prechter provides 24-hour-a-day market analysis to institutional and private investors around the world.

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