Deciding to trade professionally often requires you to adjust your mindset and perspective. One of the noticeable habits you’ll eventually develop is undervaluing the present compared to the future. Trying to forecast the future often becomes the primary focus for most traders. It’s often the sole determinant of their trading decisions and the first step on the path to trying to become an economic oracle.
Traders who particularly revere charts examine past events in an effort to extrapolate on emerging trends. Beginners and inexperienced traders have a tendency to depend exclusively on technical analysis. This strict mathematical approach heavily relies on a stong belief in repetitive and predictable patterns. If an asset’s price rebounded twice from the $100 mark, then we could assume that it’ll do so again a third time. You can also look at probability models such as the RSI for example. If it shows a value near 100 then there’s a higher probability of price declining than continuing to rise. These methods often work much better in the short term, which did cast some doubts on their long-term reliability. One of the major contributors to the success of technical analysis was the spread of automated trading systems, since these systems can only be programmed using algorithms on a mathematical basis.
While charts are a key source of information for traders, they actually play a lesser role in the path of the oracle than macroeconomic indicators and political news. The analysis of these fundamentals focuses exclusively on the long term future and by extension it’s also less suitable for intraday trading. The other downside is that a any predictions based on a mass of fundamental evens needs to be taken apart and examined in detail.
Let’s examine the EURUSD as a specific example. If you take a look at the charts for the pair, you’ll immediately see that the dollar has been steadily strenghtening over the past few years for a few different reasons.
1.) The US dollar’s interest rates have been on a rising trajectory while Eurozone interest rate stagnated in the negative. At its peak, the difference in interest rates was 2.75%, meanig the cost of a one year EURUSD currency forward transaction could be more than 300 points. It made holding long positions extremely expensive. Meanwhile interest rates working in the trader’s favor for short positions.
2.) The current administration prides itself in being on the side of business and their policies strongly contributed to the USA’s recent robust economic growth. Many US companies benefited greatly from both the tax breaks and the protectionist trade policies. EU countries on the other hand saw their economies slow down. Their situation was only made worse by the Brexit process, which has now been going on for three years. The driving force behind their economic growth used to be the auto industry, which was the hardest hit by the tariffs, causing investors to be more cautious about European stocks.
3.) The fundamentals outlined in the above two points provide a sufficient explanation for the EURUSD’s declining trend, however, there have been some ongoing changes in Europe. Most of the data over the past year have been negative, which also colors the perception of recent data for the worse. There’s actually a silver lining to low expectations, which is that when they’re exceeded, the result in a disproportionately optimistic reception. Meanwhile the US is in the opposite situation. The continuous series of promising economic reports has has made the market hopeful and confident: GDP growth that exceeds the global average, inflation below the 2% benchmark for developed countries and an overall positive purchasing manager indices. This level of growth almost seems unsustainable, so it’s natural that people would anticipate reports of a downturn. Negative reports did start showing up this summer when PMI numbers started falling short of expectations.
4.) The two economies are out of sync. On one hand the Fed is considering slashing interest rates, while on the other side the European Central Bank President claims they’ve already made every possible strategic decision they could to stimulate the economy. The European Commission only just reassembled, but they’re already suggesting centrally organized economic stimulus programs. Germany also announced their own fiscal stimulus, tax reduction and government investment spending plans.
5.) The European leadership is obviously determined to put their economy back on an upwards trajectory. Lowering the -0.5% base interest rate even further doesn’t seem to be on the agend, instead they plan to end their monthly 40 billion euro quantitative easing program after the first rate hike. The way their governments spend freely gives the bans a continuous supply of capital. Unemployment also started declining, wages are on the rise as are both retail- and corporate loans. These factors typically lead to an inflation, which necessitates an interest rate hike and it’s likely to happen in the next 10 to 16 months.
The economic processes outlined above suggest that over time the EURUSD trend is set to reverse eventually. That doesn’t necessarily mean you should rush out to buy eurosor sell dollars right now. All it means is that it’s worth your time to keep an eye on its movements for potential signs of the trend reversing over the long term.