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Stocks & Commodities V. 25:11 (16-18): Forex Focus: Fundamentals Or Technicals?

by Boris Schlossberg

FOREX FOCUS
Access to foreign exchange trading has opened up exciting trading options for the
retail trader. You can now trade alongside corporations and institutions in a highly
liquid market that is global, traded around the clock, and highly leveraged. Before
jumping into this market, however, we must understand the factors that affect the
forex market. With that in mind, STOCKS & COMMODITIES has introduced Forex
Focus to better prepare the retail trader to participate in the currency market.

Fundamentals Or Technicals?
When two are better than one: Power up your forex
trading by combining fundamental and technical analyses.

rguments between technical and fundamental traders often become fanatically intense as one side tries
to prove the other wrong. Technicians assert that all
news is discounted in price almost instantaneously and
therefore fundamental knowledge is of little use in determining the forward direction of the move. Fundamentalists state
that technical analysis offers nothing but the summary of the
past price action. After all, just as success in sports like tennis
depends not on where the ball is but where it is going, so too
in trading, profit and loss does not depend on where the price
stands currently but on where it will be in the future. Therefore, fundamentalists argue, trading technically is akin to
driving a car by looking in the rear-view mirror.

THE FUNDAMENTALS
Yet when it comes to the currency market, both technicians
and fundamentalists could benefit for each others analysis.
The currency market, which reflects the fortunes of nations
rather than individual companies, trades on big macro economic ideas such as government economic reports, central
bank announcements, and political conflicts. It is therefore
quite sensitive to news surprises and tends to create sharp
reactive moves. In fact, take a look at any hourly chart of a
major currency pair such as EUR/USD (euro/US dollar) or
GBP/USD (British pound/US dollar), and chances are the
large-volatility candles are the result of a significant economic or political surprise.
Instead of ignoring the news, technicians should appreciate the importance of news. Strongly positive or negative
news tends to have more than a momentary impact on price.
The forex market is composed of many participants, ranging
from money center banks to multinational corporations to
investment brokerdealers to retail traders. As news is distributed across the world, each of these agents exerts an
influence over the trade, often causing continuation in price.
Trading this continuation requires the skills of a technician,
as many common tools of technical analysis such as Fibonacci support and resistance zones come into play.

When it comes to the currency market,


technicians and fundamentalists could
benefit from each others analysis.
Quite often, the most immediate post-news reaction after
the initial price adjustment is the move in the opposite
direction of the news. Technical traders often make the
mistake of assuming that all of the news has been factored
into the price and they try to trade the bounce.
However, large economic surprises tend to have more than
just a fleeting impact on price. The immediate bounce after a
news event is more likely to be the result of quick profittaking by short-term speculators as well as an attempt by
dealers who have had to absorb a large amount of inventory.
The dealers run the price up against the news reaction so they
may reduce some of the risk of their position. The bounce
after a big economic surprise is far more likely to be a
retracement rather than a true reversal.

THE TECHNICALS
Fortunately, technicians possess great tools in their arsenal to
measure the possible strength and duration of the retracement
and have several money management strategies at their disposal to trade these news events effectively. Lets look at
examples that use Fibonacci retracement and extension levels
to ascertain the most likely points of entry for this type of trade.
In Figure 1 we focus on the EUR/JPY pair (euro/Japanese
yen). Over the past several years, the EUR/JPY cross has come
to represent the appetite for risk in the currency market. The
cross has become one of the predominant carry trades in the
currency market as investors tried to benefit from the widening spread between eurozone rates and the ultra low rates in
Japan. European interest rates have been steadily climbing as
growth in the eurozone has increased, while Japanese interest
rates remained moribund as the country continues to shake
off the vestiges of deflation that plagued it for more than a
decade. As I write this article, the spread between the two
stood at 350 basis points (4% for EUR and only 0.50% for
JPY). However, carry trades only perform well in periods of

Copyright (c) Technical Analysis Inc.

by Boris Schlossberg

Stocks & Commodities V. 25:11 (16-18): Forex Focus: Fundamentals Or Technicals? by Boris Schlossberg

FOREX FOCUS
low volatility and generally rising equity prices
when investors are willing to assume risk. When
stocks fall, so typically do carry trades.
On August 17, 2007, the Nikkei market
plunged more than 800 points as fears of a
global credit crunch spread to the Asia Pacific
region. The EUR/JPY fell more than 300 points
in one hour. Instead of trying to play the bounce,
technically oriented traders could have focused
on a retracement from the most immediate swing
high to enter a low-risk trade from the short side.
Prices failed at 153.58 (38.2% Fibonacci
retracement area) and an entry at the close of the
11 am Eastern time candle would have produced a profitable short.
What are some reasonable profit targets for
this setup? The first and most natural target is
simply the bottom of the breakdown candle.
In this case, that would mean the revisiting of
the 151.93 low set at 7:00 am that day. In fact,
double bottoms, which are some of the most
common patterns in technical analyses, can
be viewed as simply retests of price caused by
the sharp change in fundamentals. However,
strong news surprises tend to reverberate
throughout the currency market. They often
provide more meaningful continuation moves
than just the target of the double bottom.
As we can see in Figure 2, if we use Fibonacci
projections the price extends all the way beyond
150.38 or the 138.2% level of the original down
segment. One possible way to trade this setup is
to use two lots per trade. Since as traders we can
never be certain about the amplitude of the
move, we could take profits on half of the
position at the initial double-bottom point, moving the rest of the position to break even in order
to eliminate risk. Then we can target the 138.2%
extension as a possible second target for the
trade trying to squeeze more profit from the
move.

FIGURE 2: CONTINUING BEYOND TARGET. Here, the price extends beyond the 138.2% retracement.
You could trade this setup with two lots and take profits on half the position at the initial double bottom
and move the rest of the position to at least break even.

FUNDAMENTALS + TECHNICALS
= POWERFUL

Boris Schlossberg serves as senior currency strategist at Dailyfx.com.

In summary, we can see how the combination of


a strong fundamental surprise along with the
precision of technical analysis can produce a
powerful strategy for currency trading. By understanding that significant news surprises can
exert a continuation effect on prices, we can
apply basic Fibonacci techniques to time both
entries and exits for the news trade. In the
process, we create a logical, low-risk methodology for short-term currency trading that hopefully produces profits.

FIGURE 1: SHORT TRADE ON EUR/JPY. Fears of the credit crunch resulted in an 800-point plunge
in the Nikkei. The EUR/JPY fell more than 300 points in one hour, and the 38.2% Fibonacci
retracement fails. This is an ideal entry point for a short trade.

SUGGESTED READING
Lien, Kathy, and Boris Schlossberg [2007]. Millionaire Traders: How
Everyday People Are Beating Wall Street At Its Own Game, John
Wiley & Sons.
Schlossberg, Boris [2006]. Technical Analysis Of The Currency Market,
John Wiley & Sons.
DailyFX.com

S&C

Copyright (c) Technical Analysis Inc.