Is Near-Term Dollar Strength Coming To An End?

Dr. Kris’ Note: Jennifer Gorton from Forex Traders contacted me and asked me if I’d be willing to run an article from one of their Forex contributors on my website. Since I must admit that my Wall Street education lacks currency trading, I most welcomed the invitation. Below is their offering from Forex analyst Jason Hoerr.

By Jason Hoerr – Market Analyst for Forex Traders

Is Near-Term Dollar Strength Coming To An End?

The U.S. dollar has rebounded nicely over the last two weeks as risk assets took a beating with large corrections in gold and silver leading the way. As equity and commodity markets corrected sharply over the last few weeks, the U.S. dollar has been the primary beneficiary as an increasingly unstable global environment caused investors to rush into the safety of the dollar.

2011 Not Pretty For U.S. Dollar

The dollar has been in a one way decline for most of 2011. The Federal Reserve’s adamant stance of extremely loose monetary policy is in direct opposition to the rate tightening cycles that Europe, Australia, New Zealand, and Canada are experiencing; thus, the dollar has weakened considerably as investors move capital out of the low-yielding dollar and into higher yielding assets.

The rapid decline in the dollar has, of course, been paired with a dramatic rise in equity markets, oil, gold, silver, and other commodities. Therefore, as the dollar finds strength in this current bout of risk aversion, as investors we want to identify areas of potential resistance in the dollar index, which will in turn give a time-table for when to look for potential resumptions of bullish movement in EUR USD, GBP USD, AUD USD, and NZD USD and bearish movement in USD CAD.

Potential Areas For Continued Dollar Weakness

In the chart above, you can see that the dollar dropped significantly in 2011. The U.S. Dollar Index is a weighted financial instrument that tracks the value of the U.S. dollar relative to a basket of currencies including majors such as the euro, yen, franc, pound, and Canadian dollar.

The USDX found strong support down at the 73.00 level in early May, and the current rally to the upside is just running into an area of major price resistance at 76.00. If price can break through the 76.00 area, then the next level that should bring strong resistance is 76.80, which is an area of confluence with the 50% Fib Retracement of the overall swing HI/LO and it is also a very strong area of previous support and resistance.

Combining Technicals and Fundamentals
There are currently several major themes in the U.S. economy that will most likely make a sustained rally in the U.S. dollar very difficult. The current Congressional debate concerning the debt ceiling and sovereign fiscal concerns, high unemployment, and continued loose monetary policy from the Federal Reserve are three primary drivers of a weak U.S. dollar, and none of these appear to be changing in the near-term.

Furthermore, the European Central Bank and other central banks in the developed world are continuing to tighten policy in order to return to more normal monetary conditions following the 2008 Crisis. This continued divergence between the Fed and other central banks around the world will most likely keep the dollar under some pressure in forex trading until the Fed begins showing signs of possibly tightening monetary conditions.

Therefore, as the dollar hits these two resistance areas this week at 76.00 and 76.80, look for potential reversals and a return of dollar weakness to enter the market. A break of 74.50 back to the downside would confirm a resumption of U.S. dollar weakness.

Risk Warning: Foreign exchange trading carries a high level of risk that may not be suitable for all investors. Leverage creates additional risk and loss exposure. Before you decide to trade foreign exchange, carefully consider your investment objectives, experience level, and risk tolerance.

Dr. Kris’ Notes: As an add-on to this article, I’d like to show how you can capitalize on this information. If you’re not interested in trading currencies directly, you can still emulate a similar position with less risk but also with less reward (unless you go with options which is very do-able, providing you know how to trade options).

Consider the bull dollar ETF, the UUP. (The bear equivalent is the UDN.) The daily chart of the UUP is shown below. Although I can’t position both charts side-by-side, the UUP does track the chart of the dollar index shown above, per its stated intention.

Comparing these charts, we can see major resistance levels on the UUP at $21.75 and $22.25, corresponding to those resistance levels of 76 and 76.80 on the dollar index. The UUP breaking the first level of resistance would be a signal to initiate a long position.

That can be done by buying the UUP itself or, if you’re more bold, buying call options. Bullish behavior was exhibited today in UUP options with the 22-23 strike prices in the calls garnering the most attention. The call/put volume in the highest volume strikes was in the June 22 call and put strikes where the volume was 17,100 calls to 419 puts, yielding a ratio of 40:1. That’s pretty bullish!

Since the difference in resistance levels is only 50 cents, buying a spread may not be advisable especially considering commission costs (unless you’re trading a lot of contracts and are able to absorb it).

We’ll see how the dollar fares as QE2 winds down. For now, put the dollar on your watchlist. Remember that every uptick in the dollar makes Euro-Disney all that more affordable!

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