The Greenback Bottom

08/21/03 08:30:01 AM

by David Penn

A cup with handle bottom clashes against a 1-2-3 trendline break to the downside.

Security: DXU3, @DX
Position: N/A

Big-time bears on the U.S. economy invariably anticipate a declining dollar. To listen to these dollar doomsayers, it is as if there is no reason for anyone with the good sense they were born with to own dollars. High-falutin' bulls on the U.S. economy are quite a bit more, ahem, flexible with regard to the greenback -- which is in and of itself a bit anxiety-inducing for the rest of us. To the bulls, a weak dollar makes U.S. exports more competitive -- so it is a good thing. But, at the same time, a strong dollar shows that there is still robust demand for what has been the de facto world's reserve currency for decades -- so it, too, is a good thing. At the end of the day, the greenback can't win with the bears, and it can't lose with the bulls.

I suspect the truth, as it often is, lies somewhere in between the two. There are actually two technical pictures painted by the greenback's price action since May. The first and somewhat longer-term technical portrait is of a cup with handle bottom that begins with the May declines, continues through the early June bottom below 93 and completes its cup with the advance that culminates in early July just south of 98. The handle is currently "under construction" and has a low of about 95, reached in mid-July. This bullish picture will be fulfilled if the greenback remains above its 20-day exponential moving average and continues to mark higher highs (as of August 14th, the greenback -- basis continuous futures -- had closed higher for four days in a row). Note also the trend channel from the June lows which points presently to a higher greenback.

The trend channel extending from the mid-June lows is among the bullish factors pointing to a higher greenback.

Graphic provided by: TradeStation.

There is, however, a bearish picture. And that picture--at least technically--consists of a 1-2-3 trend reversal that began with the mid-July trendline break--the same decline that provided the handle low of the cup with handle formation mentioned above. This decline represents the "1" of the 1-2-3 trend reversal and the subsequent rally that fell just short of 98 represents the "2" attempt to re-establish the previous trend. The "3" of the 1-2-3 trend reversal remains to develop. A number "3" would be a breakdown beneath the low of the "1" trendline break--in this case, a drop in the greenback below 95.

So, bullish or bearish? Right now, the MACD indicator seems to tilt risk in favor of the downside. This is based largely on the flatness of the MACD indicator in late July and August when price action in the greenback was making a short-term bottom and reversal to the upside. If the cup with handle bottom were to develop into an upside breakout at this point, then it would be reasonable to expect some form of confirmation in the MACD, such as a higher peak in late July compared to the peak in the indicator that occurred earlier in the month.

This is not to say that the greenback could not leap upward from these levels right now. A bearish shock to gold or oil prices (see my article "Kings of Commodities," Working-Money.com, August 13, 2003) could send the dollar on what might be a premature ride upward. And few, if any, have noted that government bond yields -- particularly the ten-year note -- bottomed one trading day (a Friday) before the greenback did (basis September futures), and that both have been moving up fairly relentlessly ever since. Nevertheless, there are a number of factors -- from technical indicators like the MACD, the success of set-ups like the 1-2-3 trend reversal, and the behavior of counter-greenback commodities including physicals like oil and gold, as well as currencies such as the euro -- that will inevitably help traders anticipate just what sort of resolution comes to the greenback's current consolidation.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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CUP WITH HANDLE

The Greenback Bottom

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