Forex Blog - Following the Path of Least Resistance in Forex Trading
The â€śpath of least resistanceâ€ť is not a term you will
find in a forex trading book. It is a term I coined to describe how the forex
market tends to seek the easiest path and will avoid obstacles whenever
possible. It is like a river finding its way around the rocks rather than trying
to go over them. This is even more relevant in a global economy where cross
currency moves tend to play an increasing role. This is generally easiest to
identify when there is a clear cross trend and one of the currency pairs lags,
leaving the burden on the other pair to absorb the offsets.
In the â€śold daysâ€ť the forex market used to talk in terms
of US dollar trends. In current times, there rarely seems to be a uniform
dollar trend as crosses play a key role. As an example, take a look at a
usd/jpy chart and compare it with any other currency chart during the financial
crisis that shook the global economy during 2008-2009. For example, on September 1, 2008 eur/usd closed at
1.4605 (coincidentally around the same level it is trading at today) and
usd/jpy at 108.l7. On March 2, 2009
eur/usd closed at 1.2572 and usd/jpy 97.72. These pairs moved in opposite
directions as both the US dollar and Japanese yen firmed on safe haven demand
and the market pushed the path of least resistance, which in this case was to
buy both US dollar and JPY via its crosses.
How does this impact forex trading? A good way to explain
this is by showing an example. Today is September 15 and the currency trading focus
of the day was on sterling, which came under selling pressure following
comments from the Bank of England (BOE) Governor. The EUR/USD came into the day
in a strong uptrend but had run into resistance around the 1.4650 level. It had
paused just below this level overnight at 1.4647 after setting yet another new
2009 high yesterday at 1.4652. GBP/USD was also in an uptrend but lagging the
EUR/USD as EUR/GBP was also trending higher. GBP fell both vs. the dollar and
on its crosses following the BOE Governorâ€™s comments.
This is where the path of least resistance kicked in.
With EUR/GBP headed higher and EUR/USD reluctant to challenge 1.4650, the path
of least resistance was the GBP/USD downside. This saw a two-week GBP/USD
trendline broken as EUR/GBP broke out above .8840, sending sterling tumbling
vs. the dollar to a low of 1.6400 (vs. a 1.6660 intra-day high). EUR/USD, by
contrast, consolidated in a range with support coming from offsets from a
firmer EUR/GBP. It wasnâ€™t until GBP/USD found support that it was no longer a path
of least resistance. At that point EUR/USD moved higher and broke the 1.4650
level as EUR/GBP stayed bid.
Another way to look at it is simple algebra. In the above
example, A/B = C, where A = EUR/USD, B = GBP/USD and C = EUR/GBP. Assuming A (EUR/USD)
is more or less a constant (e.g. limited within a range), for C (EUR/GBP) to
rise, B (GBP/USD) needs to fall. Another way to look at the forex market is as
a pressure cooker. In the above example, for EUR/GBP pressures to prevent the
top from boiling over, GBP/USD had to move lower if the EUR/USD obstacle on the
upside (e.g. 1.4650) was too difficult for the market to overcome at this time.
Most times one or the other currency pair will lag in the same direction but
there are times (as with the financial crisis example described above) when
currency pairs will move in opposite directions.
Of course, there are more variables to consider, such as
the prevailing dollar trends as this path of least resistance will more often
than not lie with the trends as the market has more trouble absorbing flows in
that direction. Even if you do not trade crosses, an awareness of when they
drive spot movements is important to be aware of for forex trading. This
discussion only scratches the surface of this topic but identifying the path of
least resistance can provide some good risk vs. reward trades. Note the path of
least resistance is easier to identify when one currency stays â€śconstantâ€ť and a
trend is clear on a specific cross.
Jay Meisler is a
co-founder of Global-View.com, the leading forex discussion site for more than
a decade and where traders from around the globe come for the latest breaking
news, flows, rumors and trading ideas =>http://www.global-view.com
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