Dollar Update

The dollar has continued to rally lately and it's even set some new highs (or lows on the Eur/Usd pair--it is bullish when the price goes down on the pair because it takes less dollars to buy a euro) So why is the dollar rallying when the economic outlook of our nation looks really bad right now? There are some good theories out there (e.g. flight to safety, interest rate cycle...). In my opinion, one person who is really on top of the fundamental picture with the dollar is Warren Mosler. Our Federal Reserve has entered into agreements with the European Central Bank to essentially guaranty their entire financial system by loaning them an unlimited amount of dollars. One of the problems with this arrangement is that the euro and the ECB is not guarantied by the individual countries that make up the European Union, unlike the dollar which is completely guarantied by America.

If the EU goes under, it will obviously hurt our country in many ways, especially if they're defaulting on their debts to us...but is that likely? Now let's look at the situation and ask ourselves how it will likely play out if the EU doesn't go under; I know, the less "doom and gloom" view is not as exciting, but it's practical. Although I can't predict the future, I can look at what must happen in order for them to pay us back. The ECB will have to convert euros to dollars. In forex terms, that means sell the euro and buy dollars. This is very bullish for the dollar...central banks tend to have an impact when they make hundreds of billions of transactions in the currency markets.

That's one of the fundamental reasons for the dollar to appreciate, but as some of you know, I tend to trade off of the technicals. That's why I've provided my thoughts on where the dollar currently stands by using a multi-time frame trend analysis. Below are the monthly, weekly, daily, and hourly charts for the Eur/Usd pair with some of my comments for each time frame. Remember, the price going down on the chart is bullish for the dollar because the strength of the dollar is inverse to the price move on the Eur/Usd pair.

The monthly chart paints a pretty bearish picture for the Eur/Usd pair...which is bullish for the greenback. It's significant that the price has broken the 50 period moving average (the red line). Not to mention the MACD is bearishly pointing down and the 10 period ema (aqua blue line) is pointing down. Next is the weekly chart. I like to look at the longer-term trends and pair up my shorter-term trades to be in line with the longer time frame. The trend channel (brown shaded area) is pointing lower. The 10 period Ema is below the 50 period ma. These things tell me that I want to be looking to go short the currency pair.
The daily chart confirms that going short is the right direction go. You can see that the Eur/Usd broke to new lows and started the down trend back in August and it has recently made new lows...indicating that the trend is still intact. This makes me really want to be on the short side. Now it's just a matter of waiting for a good entry point for the trade. There are a couple of things that I'll do in this situation. First, I'll wait the for pair to rally on the daily chart and sell when it gets up to the top of the trend channel. Second, I'll pull up the hourly chart to look for favorable entry signals. Another thing that I'll consider is taking on a small position here (very small) and setting my stop loss out quite a bit (maybe above the center line in the trend channel) while also considering adding to my position if it starts making money. Let's look at the hourly chart to see where we're at right now.
The hourly chart shows that the dollar has gained quite a bit in short amount of time. It gained 100 pips during Henry Paulson's speech tonight, which was quite a move. The bottom line is that the risk to reward is a little high for entering a position right now. My signal to go short flashed at the second to last pink down arrow, which was alomst simultaneous to the 10 ema crossing below the 50 sma. That was also the time that the pair broke out of it's range that it had been trading in from October 10th to 15th. The point is that my trading system says to be going short the pair (long the dollar) and that I need to wait for a rally or a new trading range to form before I establish a position, unless I take a very small position now to see if the strong down trend continues.

There are plenty of fundamental reasons to go long and short the dollar, put personally, I could really care less what they are because the trends on the charts paint the picture for me. Everyone has to develop a system that works for their own personality and this seems to be what works for me...at least for now. Just thought I'd share my perspective when I'm looking to enter a trade.

Good luck out there.

TLT