Tempered expectations that the Fed may lower interest rates may have boosted the dollar in the short term, but the global reserve currency is still likely to decline in the medium term, having reversed to a downtrend.
Investors were in for a rude awakening after Fed Chair Jerome Powell's speech yesterday. While he reiterated the central bank is reassessing the downside economic risk and recent weak economic data amid a prolonged trade war warrants a rate cut, Powell underlined the Fed is in no rush to act but will wait for a wide range of corroborating data. The Fed Chief also took the opportunity to reassert his independence of the U.S. President.
St. Louis Fed President James Bullard cut to the chase, saying the 50 basis points the market expects is unwarranted.
So, should investors get back into the dollar? Here's what the chart reveals about the supply-demand balance of power.
DXY Daily Chart
The greenback began showing signs of weakness when it failed to overcome the April peak. Matters became worse, and quickly, when supply overcame demand, pushing prices below the May lows, completing a double-top reversal.
Another attempt this month to tread higher failed to even reach the April-May levels, when the U.S. currency plunged in a four-day runoff to levels below the uptrend line since May 2018. This included a drop below the 200 DMA for the first time since May 2017 (on March 20 it slipped less than 0.1% below, but jumped right up in the next open) preceding an 11% plunge in the following nine months.
The trading pattern among the failed attempts to post higher while registering lower completed a peak-and-trough reversal, with the minimum two peaks and troughs establishing a downtrend.
Note, there is a more demanding interpretation that doesn’t include the peak of the prior trend—the May high in this case—requiring another climb to post the second lower peak since the June high, followed by a trough lower than Tuesday’s 95.84.
In our case, the peaks and troughs also formed a descending channel, an evenly and clearly marked boundary for the highs and lows, which help with entries and exits of trades, as the symmetrical downward range tends to persist. Why would a channel endure, and why would prices go up and down, even with no twists and turns in either geopolitics or policy?
Financial assets are seldom priced according to fair value. If they were, trading would be obsolete as there'd be no apparent incentive. Financial assets tend to oscillate between overbought and oversold conditions, as human beings exaggerate responses to events and to investing opportunities. That’s what traders rely on.
The downtrend framed within the descending channel is not merely a visual representation of prices. When people make or lose money, it has an affect on them, either encouraging or discouraging their expectations. Therefore, when important support or resistance is breached, people make or lose money. In this case, the fall below the uptrend line and the 200 DMA triggers stop losses, removing their demand from the equation, further weighing on the dollar, attracting short sellers, who push it even further down, heating things up.
Why, then, would there be a correction? People second guess themselves, and want to take out profits before they lose them, leading them to add to demand, as they cover the short. After that relief, traders want to go in for another round, pushing prices back down again, even further, extending the downtrend.
Trading Strategies
Conservative traders would wait with a short for a return move to the top of the channel, which may coincides with the 200 DMA. Then, wait for evidence of resistance, with the minimum of one long red candle engulfing a green or small candle of either color.
Moderate traders may wait on a short for the pullback to the 200 DMA, even if not to the channel top, and wait for selling to increase; alternatively, wait for a correction till the channel top, without waiting for confirmation of resistance.
Trade Sample: Short Position
- Entry: 96.80
- Stop-Loss: 97.00
- Risk: 20 pips
- Target (NYSE:TGT): 96.40
- Reward: 60 pips
- Risk-Reward Ratio: 1:3
Aggressive traders may risk a contrarian, long position, counting on a correction within the descending channel.
Trade Sample: Long Position
- Entry: 96.00
- Stop-Loss: 95.80, below yesterday’s low
- Risk: 20 pips
- Target: 96:60
- Reward: 60 pips
- Risk-Reward Ratio: 1:3