Tuesday, December 14, 2010
It's been a terrific run higher.
The U.S. dollar was sunk beneath an ocean of bearish sentiment just six weeks ago. But somehow it managed to float back to the surface, catch some air, and sail above the waves.
Take a look...
In early November, the dollar index traded at 76 – just a fraction above its low for the year. Last week, it peaked above 81. That's a 5% gain in just five weeks.
Of course, that may not seem like much in a stock market environment where Chinese IPOs double overnight. But for a currency, 5% is a huge move.
For the past week, however, the dollar has been sinking again. That action is prompting a lot of folks to ask, "Is the dollar rally over?"
That's a good question. So let's try to come up with a good answer...
Take another look at the chart. The first thing to notice is the dollar rally occurred without developing negative divergence on the MACD momentum indicator (the lower graph).
This indicator is used to gauge the strength or weakness of a rally. If the MACD is moving higher as a stock rallies, the momentum is strong and the rally is likely to continue. On the other hand, if a stock rallies but the MACD indicator lags behind, the momentum is weak. This "negative divergence" is a warning sign the rally may be nearing an end.
There was no negative divergence during the recent dollar rally. It would take one more thrust higher for the dollar, while the MACD lags behind, to set up a negative divergence. This argues in favor of the dollar rally continuing.
Also, it's common for stocks that are in a downtrend and have suffered a significant decline to rally and erase roughly 50% of those losses before resuming the downtrend. So even the dollar bears have to be prepared for a move back up to 83 or so on the dollar index before the longer-term downtrend resumes. Here again, this argues for at least one more move higher.
On the downside, the dollar index has support at about 78.5. A break below that line would be bearish. If that happens, the dollar rally is over and it'll be headed back down to test last December's low below 75.
Right now, the odds favor the dollar rally continuing as soon as we get through the current short-term weakness. But if the index breaks below 78.5, all bets are off.
Best regards and good trading,
Jeff forecast the current dollar rally in October. You can read the full prediction here: We Could See a Huge Rebound in the Dollar Right Here.
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