How to trade the coming rally in the US Dollar

By | September 21, 2017

There are many fundamental factors that govern the value of the U.S. dollar. It is a complex matrix of competing forces, but the way those dynamics transcribe to the price charts is fairly simple to understand. The dollar has been moving lower and now it looks like a transition in the direction of the trend may be underway. A look at the charts on multiple time frames outlines the way to trade the greenback.

The weekly chart of the U.S. Dollar Index puts the analysis in context and shows a potential reversal pattern forming. The dollar broke off a long-term consolidation channel in late 2016, but it proved to be a false breakout and this year it has retreated back through the consolidation range to the $91 area. This downside move constitutes a 38% retracement of the 2011 low and this year’s high range. Now a key candle reversal pattern is forming at this potential support level.

The “morningstar” is a three-period bullish reversal pattern consisting of a large dark candle, followed by a narrow opening and closing range “doji” candle, and completed by a large white candle. It suggests a transition in investor sentiment from bearishness-to-bullishness. A strong close this week would form the final candle in this process and could potentially reverse the trajectory of the trend. The trade, however, is triggered by the action on the daily chart.

The PowerShares DB U.S. Dollar Index Bullish Fund (UUP) is being used to illustrate the action on the daily chart. For the last seven months, it has been trading in a declining channel below its declining 50-day moving average. This month it looks like it is attempting to form a very small inverse head-and-shoulders pattern or similar rounded bottom base.

The momentum indicators suggest an internal shift in direction is underway. Moving average convergence/divergence has been moving in bullish divergence to price, and the stochastic oscillator is tracking higher and is above its center line. Chaikin money flow is in positive territory and the accumulation/distribution line has crossed above its signal average for the first time in a long time. These are signs of renewed buying interest in the dollar.

The basing on the UUP is taking place below the $24 level and that is the initial trigger point to watch. Two consecutive upper candle closes above $24 would be the first in a tiered entry into what should be a long-term trade. A confirmed break above the 50-day moving average and the declining channel downtrend line would be a second entry point. The thesis of the trade is that a major shift in the long-term direction of the U.S. dollar is underway and it should offer opportunities to add to a long position as it develops. That, of course, will take time and traders and investors should be patient and let the charts be their guide.

(published today on TheStreet.com)

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