by Darrell JobmanProbably no market has gotten more attention in recent months than the U.S. dollar. And deservedly so: The fate of the dollar is one of the key factors in the pricing of a number of other markets in addition to the currencies, an excellent example of the value of intermarket analysis in making a trading decision.
Much of the focus on the U.S. dollar has centered on whether previous lows would hold and provide support from which the value of the dollar could recover. These key points are indicated on the 18-month VantagePoint chart for the U.S. Dollar Index (USDX) below, rounded off to show the neighborhood where trading activity might become the most hectic if the USDX approached those levels (red boxes).
USDX futures hit their lows in March 2008 around 71.00 and then again during the summer of 2008 around 72.00. You might recall that’s when prices were hitting all-time highs for commodities such as crude oil ($147 a barrel) and soybeans ($16-plus per bushel). When the dollar was weakest, commodity prices were the strongest.
That suits agricultural producers and other U.S. exporters, who like a weaker dollar because it makes their goods more competitive in the global marketplace. Of course, other countries also are seeking a competitive edge so there is always plenty of political and monetary give-and-take in the forex marketplace.
You probably don’t need a reminder what was happening when USDX futures were hitting their highs around 89 and 90 in the fall of 2008 and March 2009: Prices for many stocks and commodities were plummeting during the credit crisis that threatened the world’s financial system, and traders were looking for refuge in the dollar. When the stock market caught its breath and moved back up in late 2008 and again this spring and summer, the value of the dollar declined.
You probably are also well aware of the scenario that says that the billions and trillions of dollars for various stimulus and bailout programs will lead to high inflation rates and a weaker dollar. One of the market’s favorite pastimes now is watching to see how the dollar will act as it reaches previous lows and wondering with each break of the lows, “Is this the beginning of that inflation that is causing so much concern?”
No one knows exactly what the markets will do. One might surmise that if commodity prices begin to fall, the value of the dollar will rise. Or, conversely, if the dollar value continues to weaken, commodity prices will rise, perhaps leading to the commodity price boom that some analysts expect. But there is no sure thing.
Traders can look at charts and come up with subjective conclusions, as stock index traders did recently when they first spotted a head-and-shoulders top and then, when that formation was negated by price action, decided the market was actually making a longer-term head-and-shoulders bottom. Traders cannot predict what will happen; they just need to be prepared to react to what does happen.
So now we come to how VantagePoint’s indicators fit into the picture. A six-month VantagePoint chart of USDX futures highlights the key highs since the peak in March, but the most important number currently at the hard right edge of the chart is what the dollar will do after penetrating the June low below 78.50.
Is last week’s fall to the 77.50 area just another fakeout jab in the bigger picture? Or is it only a temporary stopping point on the way to the next low? How can one trade a market like this – and, by extension, all of the other markets influenced by the dollar?
The one-month VantagePoint continuous USDX futures chart below zooms in a little closer to recent action. What we are trying to do here is not make a subjective judgment about future prices but use VantagePoint indicators to find an exact point to take action. Either the market will exceed that point or it won’t. If it does, traders need to be prepared to manage the resulting trade carefully in this active market.
It is easy to see subjectively that the USDX was in a downtrend during the last half of July as VantagePoint’s predicted medium-term moving average (blue line) was below the actual medium-term moving average (black line), the Predicted Neural Index (gray line in bottom panel) was at 0.00 and the predicted moving average differences (green and brown lines in bottom panel) all pointed down.
All well and good, but where is our trading point? For this, we are going to look to VantagePoint’s predicted next day high and low, using a strategy we have discussed in previous newsletter articles. Yes, this strategy does use predicted values but in a way that provides an objective channel for action.
When the market is trending down, what we are looking for is a breakout to the upside, supported by confirmation from the Predicted Neural Index and the angle of the predicted difference lines. In this case, we are using the predicted next day high plus 20 points – you may want to set other parameters. If the market hits this price, you are in a long position at that price (assuming no gaps, slippage, etc.); if it doesn’t, you can make a new decision tomorrow, perhaps at a lower price..
Let’s work through the candles on the chart to see how the trades unfold:
Candle 1 – The predicted high for the day was 79.06, the long entry point would have been 79.26, and the actual high was 79.21. So no position. But that candle provides important clues because it is the first white candle after a string of mostly black candles, indicating the close for the day was above the open; the predicted medium-term moving average (blue line) points up slightly for the first time in several weeks; the predicted difference lines point up (blue arrow), and the Predicted Neural Index has shifted to 1.00. All suggest strength or at least some lessening of downward momentum.
Candle 2 – Predicted high 79.33, long entry point 79.53, actual high 79.81. That produces a long position at 79.53 (red dashed line) with an initial stop at 78.47 (predicted low of 78.67 – 20 points). The stop moves up the next day to 79.13 (predicted low of 79.33 – 20 points).
Candle 3 – With a long position, we are now interested in the predicted low for a protective stop. Predicted low 79.11 – 20 points for a stop at 78.91(red dashed line). Actual low 78.31. Assuming you got out at the 78.91 stop, the loss is 64 points (79.53 long entry – 78.91 stop). You might also have gone short on this downside breakout, but a couple of factors mitigate against that: (1) Reversing from long to short requires two trading decisions instead of one – can you handle that? – and (2) would you have the discipline to go short going into support from a previous low? Your judgment.
Candle 4 – Predicted high 78.01, buy stop at 78.21, actual high 78.24. You are just barely into a long position again with an initial stop at 77.08 (predicted low of 77.28 – 20 points) adjusted almost immediately for the next day to 77.66 (predicted low of 77.86 – 20 points).
Candle 5 – USDX futures take off, hitting an actual high of 79.21 last Friday – a 100-point profit if you use a profit target. If you hold the long position, your stop coming into this week was at 78.29 (predicted low of 78.49 – 20 points), meaning you should have had at least a small profit if the market did turn down.
A couple of caveats: There is no guarantee that the trades mentioned could actually have been executed at any of the prices indicated. And the situation by the time this article appears online could be totally different than the situation coming into the week.
The point is that short-term traders should have orders in place to react quickly to price moves and trend changes when a strategy tells them to do so. And traders in almost every market should keep in mind what the U.S. dollar is doing.
Darrell Jobman.
Source: VantagePoint Intermarket Analysis Software
