Rally vs. Dollar – Update

Since I last reviewed the market’s rally and the correlation to the dollar, the markets have continued to grind their way slightly higher. This bodes the question of whether or not anything has changed since my last review.

First, I’ve previously made my case that the rise and/or fall of the dollar is the key to the next major move in the market.  There has been a very obvious inverse link between the dollar and the equity markets. To review my take on this link, please go to: http://www.themeshreport.com/tuesday’s-sell-off-or-2-day-rally/ and http://www.themeshreport.com/time-to-look-at-the-dollar/

With the above articles in mind, please take another look at the dollar index, which I have included below:

Even though the markets have ground out slightly higher gains over the past couple of weeks, the dollar is holding its ground above its trend line support. Eventually, the dollar will have to do one of two things:  Either 1) Continue, and most likely accelerate, higher, or 2) Break support and continue much lower.

The reason why I say “accelerate” is because of the extreme bearishness I discussed in my previous articles. If the dollar were to gain any momentum on the upside, I would expect the equivalent of a short squeeze. However, if the dollar were to break lower, that could be the fuel needed for another leg up in the markets.

Ultimately, I believe that the Fed decision on Wednesday could be the piece of data needed to answer the question as to what the dollar’s next move will be. The obvious thought would be that the Fed’s issuance of QE2 would cause the dollar to move lower, but could it instead be a case of “buy on the rumor, sell on the news” for the markets?

The Tale of the Tape: The dollar appears to be the linchpin for the stock market’s next move. Probabilities say the dollar will hold support, in which case a long play on the dollar and/or short position on the market would make sense. However, if the dollar were to break support, shorting the dollar and/or entering new long positions in the stock market would most likely be the best trading opportunity.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Tuesday’s sell-off, or 2 day rally

Monday I wrote a Chart School article in regards to the need to watch the dollar index for a potential turn higher. My belief is that if the dollar were to turn higher and embark on a strong rally, the stock and commodity markets would in turn begin to decline.  This correlation is relatively well known, but some readers have emailed inquiring for more input on this correlation.

I don’t spend a lot of time trying to decipher the “whys” within the markets, but instead I let the charts themselves to do the talking. For this discussion, I will use the SPY (S&P ETF), UUP (US Dollar ETF), GLD (Gold ETF), SLV (Silver ETF), and the VIX index. First, take a look at the following charts of the SPY, GLD, and SLV:


Lets first recognize the correlation between the stock market (SPY) and the commodity markets (GLD and SLV).  Specifically, notice the green-circled areas on the 3 charts. Tuesday’s drops were all in sync, and on much higher volume than Wednesday’s rally. So, although the stock market regained all of its Tuesday losses between Wednesday and this morning, the rally has been on lighter volume and the commodity markets have yet to follow. Is this divergence between commodities and stocks a reason for concern?

Now, to see the inverse correlation of the above markets to the dollar, please review the chart below of the UUP:

You can see that the dollar (UUP) has been moving in the exact opposite direction as the stock and commodity markets. Once again, notice the green-circled area and you will see a jump on Tuesday rather than a rally. You will also notice the same volume increase and decrease. As with the commodity divergence, you will see that the dollar has yet to hit a new low even though the stock market has hit new highs over the last 2 days. Who’s right: The stock market, or commodities and the dollar?

Well, are traders/investors getting less fearful, or more fearful? Let’s look at the VIX, which is the volatility index:

A common definition of the VIX is “the fear gauge”.  The idea is simply that when the VIX rises, traders and investors are getting more fearful. So, although it isn’t necessarily “lock in step”, when the VIX moves higher the stock market commonly falls and vice-versa. Interestingly, as the stock markets have inched higher, so has the VIX. Are traders and investors getting more fearful of a market fall? Are the commodity and currency markets confirming this?

Bottom line, the charts above clearly demonstrate that when the dollar is rising/falling, commodity and stock markets are falling/rising and vice-versa. Even though the stock market has continued higher after Tuesday’s sell-off, commodities and the dollar have diverged along with volume.

The Tale of the Tape: The market rally, or potential topping point, hinge on the dollar’s movement. The US Dollar Index (please review Monday’s article: http://www.themeshreport.com/time-to-look-at-the-dollar/) has approached a very significant trend line of support. Unless the dollar breaks lower and the commodities catch up with the stock market, a sell-off seems to be impending.

So, enter new long positions with caution. Protect your portfolio and feel free to “dip your toe in the water” with a short position, but don’t get crazy. Watch the US Dollar Index and commodities for an “all clear” signal, which for the US Dollar Index would be a break of support.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Time to look at the dollar?

Back in August I wrote an article in regards the US dollar and its prospects at that time. (To review that article, please go to: http://www.themeshreport.com/and-then-there’s-the-dollar/) In that article, I analyzed the UUP as a way to review the dollar’s trend and support/resistance points.

The UUP is an ETF that allows investors to buy the dollar without actually buying the currency. In today’s market, there has been a decent correlation to the dollar’s movement and the stock market’s movement, but in the opposite direction. So, knowing what the dollar is doing can not only help you know when to trade the dollar currency if you choose, but it can also give you some insight as to what the stock market may be doing, or getting ready to do.

Below is the chart I provided of the UUP back in my August article:

At that time, it appeared that the dollar was breaking higher when we noticed the UUP breaking through its down trending resistance level (red). However, I also mentioned that there might be a concern for the dollar if the horizontal support at around $23.25 were to give way. Now, please look at an updated view of the UUP:

You can see that rather than starting a renewed uptrend, as I personally thought it was doing, the dollar instead turned lower. In September the UUP broke the key level of support at $23.25 that I referenced in that previous article. This was a sign that the UUP/dollar was probably heading lower, which they both did.  As I mentioned at that time, a break of that level would be a great opportunity to short the dollar or UUP.

Well, what’s next for the UUP/dollar? My belief is that the dollar is close to embarking on a new uptrend. Why? Please look at the following two charts:

The first chart above is a 3-year view of the UUP. What you may notice is the obvious support level at $22 on the UUP. The second chart is of the US Dollar Index itself. Notice the long-term up trending support line that I have added. Both of these charts show an immense amount of support at current levels, or close to them. Volume has also been somewhat interesting on the UUP over the last few months as well.

Also, are you a contrarian trader? If so, the Daily Sentiment Index provided by trade-futures.com shows a sentiment reading of 3% on the US dollar. This is EXTREME bearishness. If you need a reference, you might ask what the sentiment reading was back when the dollar bottomed at the end of 2009? 7%. If sentiment is an indicator you use, doesn’t it sound like now could be a time to consider going long on the dollar, especially at the current support levels? Could this also spell trouble for the stock market if a bullish dollar analysis is correct?

The Tale of the Tape: After breaking key supports in September, the dollar fell lower as one might have expected. The UUP/dollar have both reached very important support levels once again. Bearish sentiment has also reached an extreme. This could be a great time to look at entering a long position on the UUP/dollar (one could also short the euro). It might also be a good time to watch for a breakdown in the stock market.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Trade Watch – PLCE: Follow up

PLCE is a stock that was recently analyzed in a Chart School, “Trade watch” newsletter. To review that article, please follow the link: http://www.themeshreport.com/trade-watch-plce/

Since analyzing PLCE for potential trading opportunities, the stock has made an important move. Please look at an updated chart of PLCE below:

As you can see, PLCE made a significant breakout on Friday. Not only did the stock break through the key resistance level of $50, but this is also a new 52-week high! In addition to the breakout, there was nice increase in volume on the day of the breakout. As the saying goes, “Volume equals validity”. In other words, a high increase in volume on a breakout adds credibility to the move.

The Tale of the Tape: PLCE has broken out through a key resistance level to a new 52-week high. This usually signals a new move higher is to come for the stock. You could enter the stock here, or wait for a pullback to the old $50 resistance in expectation of the same $50 level acting as new support. Either way, a stop below the $50 level would be advised in case the breakout fails.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT

Trade watch – CXO

From time to time, I would like to give readers a heads up on potential trading opportunities. Before considering any trades that I might outline in Chart School, always remember that you must decide for yourself if you like the trade.

A key factor in making that decision will be coming up with which side of the trade you believe gives you the highest probability trade. In other words, do you like the short side of the market, or do you like the long side? You don’t necessarily have “know” what side to be on, but it certainly helps to take a stance. So, if you haven’t thought about it, review the overall indices themselves. Take a look at the S&P 500 for example.  Is it trending higher or lower? Has it recently broken through a key resistance or support level? Making these decisions ahead of time will help you decide which side of the trade you believe gives you the best opportunities.

One trading opportunity that I’d like to review today is that of CXO (Concho Resources).  Before discussing, please review the 1 yr. chart of CXO that I have outlined below:

If you have read any of my previous Chart School newsletters, you will already know that I believe the simplest to be the best. In my experience with other traders and students that I have coached to trade, the ones that kept it the simplest always seemed to do better than others who may have overcomplicated things a bit.

This simplicity is on full display when you look at the chart of CXO above. CXO has formed a common price pattern called a Rising Wedge. This type of pattern tends to have bearish implications. A break below the up trending support level would confirm the pattern. The decrease in volume over the last 2 – 3 months is a common “calm before the storm” with patterns such as these.

The Tale of the Tape: CXO (Concho Resources) has formed a Rising Wedge price pattern over the last 4 – 5 months. Volume has also been drying up as the stock has continued higher. If CXO were to break above the up trending resistance on above average volume, entering a long position could be advised and the bearish implication of the pattern would be nullified. If instead CXO were to break the up trending support level, the pattern would be confirmed and a short position would be advisable. Could you enter a long position if CXO approaches that same support? The wedge pattern does not mean that CXO is definitely going to break lower, so yes, you could enter a long position when CXO approaches the up trending support.

No matter what your strategy or when you decide to enter, always remember to use protective stops and you’ll be around for the next trade.  Capital preservation is always key!

Good luck!

Christian Tharp, CMT