What Is the Path of Least Re3sistance – A Primer in Forex Trading

By: Jay Meisler Click author's name for more of his/her articles

The “path of least resistance” 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. I 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 “old days” 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 (which is around the level trading 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 affect forex trading? One way to illustrate 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 another new high for the year 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 Governor’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 the pound tumbling vs. the dollar to a low of 1.6400 (vs. a 1.6660 intra-day high). On the other hand, EUR/USD consolidated in a range and the downside was cushioned by support coming from offsets from a firmer EUR/GBP. It wasn’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 of the time one currency pair or the other will lag in the same direction but there are other 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. The path of least resistance is easier to pick out when one currency stays in a range and a trend is apparent on a specific cross.

Copyright (c) 2009 Jay Meisler

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About The Author: 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 =>www.global-view.com