Investopedia’s July 2012 Forex Outlook

Investopedia’s July 2012 Forex Outlook: Macroeconomic Highlights

As we move enter July, the global economy continues to struggle amid a lackluster U.S. recovery and ongoing indecision and banking problems in the eurozone. Asia has also started to feel the slowdown after posting several years of strong growth rates, which could pose further problems for the financial markets, taking away a key source of global growth.

Macroeconomic Highlights

U.S. Slows, Extends Operation Twist
The U.S. economy appears to be slowing by many accounts. On June 20, the U.S. Federal Reserve lowered its outlook for the year to 2.4% from its 2.9% projection earlier this year. Unemployment isn’t expected to improve much either, with the jobless rate expected to fall no lower than 8% by the end of the year, according to the same report by the central bank.

Many U.S. economic indicators have also confirmed this slowdown. The U.S. manufacturing sector grew at its slowest pace in 11 months in June, while new unemployment claims fell only marginally in recent weeks. Meanwhile, existing home sales fell 1.5% to a 4.55 million annual rate in May, according to the National Association of Realtors.

As a result, the Federal Reserve opted to extend its bond-buying program known as “Operation Twist” until the end of the year in response to this slowdown. Under the program, the central bank will continue purchasing U.S. Treasury Bonds. But while the news came as a surprise, the effects were short-lived, and the stock market reversed within hours of the announcement.

Euro Worries Persist, Calls on Germany

Spain’s bailout may have averted a near-term crisis, but the lack of a cohesive rescue plan means worries still persist. Bond yields for troubled countries like Spain and Italy remain near unsustainable levels, despite a brief reprieve. Meanwhile, Moody’s recently downgraded 15 of the world’s largest banks, adding to concern in the financial markets.

The most popular solution to these woes are so-called Eurobonds that would be jointly guaranteed by all members of the monetary union. Former British PM Tony Blair perhaps said it best: “The only thing that will save the single currency now is in a sense a sort of grand plan in which Germany is prepared to commit its economy fully to the single currency.”

Unfortunately, Germany remains very resistant to the idea. German Chancellor Angela Merkel has shown no signs of budging on Eurobonds or bank guarantees amid pressure from newly elected French President Francois Hollande. Merkel instead insists that euro states must agree to much deeper fiscal integration before such financial pledges are made.

Asian Growth Continues to Stumble
Asia may be the world’s growth driver, but those rates appear to be slowing. Chinese manufacturing activity weakened to a seven-month low in June, according to an HSBC survey, indicating deterioration in business conditions at factories. Meanwhile, there are also some concerns that government data may be overly optimistic.

A notable exception is Japan’s economy, which is expected to continue seeing a modest recovery driven by strong consumer spending and rebuilding efforts. Recently, the government also upgraded its outlook on capital spending for the first time in three months, citing a pick-up in corporate profits and support from the reconstruction.

Britain’s Signs of Recovery After Double-Dip
Britain has taken a unique approach to combatting its economic decline. Unlike the U.S. and eurozone, the region has instead opted to impose austerity measures and hike taxes. While it recently slipped into a double-dip recession, the country’s leaders insisted this was primarily due to higher commodity prices, a weak banking sector, and the eurozone crisis.

Despite the slowdown, there are also some signs of a turnaround after new lending and infrastructure initiatives were implemented. Retail sales increased in May after a weak showing in April, with the Office for National Statistics showing a 1.4% gain in May. These figures were above economist forecasts of a 1.2% increase for the same period.


Elliot Wave Theory and Principle

Although my system mainly focuses on Channels and Fibonacci retracements, I also pay attention to the Elliott Wave Theory, because it provides vital information about price movement.

The Elliott Wave Principle is a type of technical analysis that utilizes past cycles or repetitive patterns to identify predictable market behaviour. It was developed by Ralph Nelson Elliott, who published his theory of market behaviour in the book, “The Wave Principle” in 1938.

According to the theory, the market moves in repetitive cycles. These cycles represent the emotions of investors, caused by outside influences or the general psychology of the population. These emotions cause repetitive price swing patterns, called waves, and being familiar with these behaviours can help identify where the price will probably go next.

There are two types of waves, impulse and corrective waves. Impulse waves follow the main direction of the waves, while corrective waves go against the main direction.

In a trending market, a combination of these waves make up a complete cycle of 8 waves, which is composed of two major types of wave patterns. The first type is the 5-wave impulse pattern followed by a 3-wave corrective pattern.

In an uptrend, the 5-wave impulse pattern consists of 5 waves, with waves 1, 3 and 5 as impulse waves (going up), and waves 2 and 4 as corrective waves (going down). Once the impulse pattern has formed, it is normally corrected by a 3-wave cycle. Wave A and C are impulse waves (going down) and wave B is a corrective wave (going up).


In a downtrend, the 5-wave impulse pattern also has 5 waves, but the impulse waves 1, 3 and 5 are going down, and the corrective waves 2 and 4 are going up. The 3-wave corrective pattern also has 3 waves, with the impulse waves A and C going up, and the corrective wave B is going down.


The waves can be classified in different degrees. Here is the general standard order of degrees with their approximate duration:

Grand Supercycle                Multi-century
Supercycle                            Multi-decade (about 40-70 years)
Cycle                                      One year to several years
Primary                                  A few months to a couple of years
Intermediate                          Weeks to months
Minor                                      Weeks
Minute                                    Days
Minuette                                Hours
Subminuette                         Minutes

The 5-wave cycle is also known as the 1-2-3-4-5 pattern, and once it has formed, it is normally corrected by a 3-wave cycle, also known as the ABC pattern.

Each wave of has its unique characteristics. Here is a summary of the different types of waves.

Wave 1 – impulse

This is the initial move towards the new trend direction. In an uptrend, the first wave is going up. A small number of people thought that the price was low so they bought the currency, and this caused the price to rise.

Wave 2 – correction

Seeing that the price has gone up considerably, traders who bought the currency at the beginning of wave 1 usually take their profits by this time. This causes the price to go down again and become very attractive to more investors. Wave 2 usually retraces at Fibonacci levels, and it never goes lower than the low of wave 1.

Wave 3 – impulse

By this time, more and more investors would have noticed the currency’s beginning trend, and so more people would dive in the market, making this wave normally longer and stronger than the other waves.

Wave 4 – correction

By wave 4, the price has gone considerably high in an uptrend and very low in a downtrend. Traders take their profits again. Although price makes a correction, it’s not strong enough to even reach the high of wave one. Wave 4 also retraces with respect to Fibonacci levels as well.

Wave 5 – impulse

The price may have retraced in wave 4 but is still overpriced or underpriced. However, most traders will still get in the market unreasonably. Wave 5 can also be the longest of the waves, but if wave 3 is the longest, then wave 5 is usually about the same length as wave 1.

At this point, there will also be traders who recognized that price has become extremely high and start selling, and thus, start the 3-wave correction or the ABC pattern. Normally, this pattern ends near the low of wave 5. There are many types of ABC patterns, but I pay more attention to flags and triangles, and we’ll talk about those in another section.

Normally, corrections are more difficult to identify than impulse moves.

Wave A – impulse

When the wave A appears, the original trend is still active.

Wave B – correction

Prices return to the direction of the trend. However, it fails to exceed the maximum high level for an uptrend or maximum low level in a downtrend. At this point, we normally see reverse pattern signals like double tops or head and shoulders.

Wave C – impulse

By wave C, the prices have obviously reversed and a new trend to the opposite side is well-established. Wave C is usually as long as Wave A or longer.