US Dollar at Critical Juncture

Throughout 2017 the US Dollar Index (USD) performed a steady, methodical downtrend.

USD is a weighted index representing the US dollar’s value relative to a basket of other global currencies. Its largest constituent, the Euro (EURUSD), represents around 57% of the index and has been in an uptrend since the start of the year. Accordingly, strength in the EURUSD is offsetting any uptrend potential in USD.

US Dollar

Looking at the long-term view of USD we can see that the index retraced all the previous gains it made during 2016 in the past five months of 2017.

Additionally, this potential reversal of the previous primary trend took USD from the upper boundary of its price range formed during 2015-2016 to the opposite lower boundary of the range. At the same time, while price continued to make a series of higher highs, USD’s Moving Average Convergence Divergence (MACD) indicator is exhibiting negative divergence by posting a series of lower highs.

At the moment, USD is facing a meaningful test at this key support level which market participants have used as a strategic buy point over the last two and a half years.

Consequently, what once appeared to be a healthy uptrend with a series of higher highs and higher lows since late 2011 may be a jeopardy.

On the weekly chart we can see more clearly how the weekly closes are providing a line-in-the-sand for USD. Corresponding with these price lows is a new low, extreme reading in weekly the Relative Strength Index (RSI). In fact, this indicator is at its lowest level in the past five years.

Typically when RSI reaches this level it represents a very oversold market. However, weak markets can become weaker just as strong markets can become stronger.

On the daily chart we see similar developments. For example, since its peak at the end of 2016 USD has made a series of lower highs and lower lows.

In the process USD sliced through its 200-day Simple Moving Average (200SMA). The 200SMA is a long term trend indicator. Generally speaking, it is best to be long assets over the 200SMA and out of or short assets below the 200SMA.

While USD’s trend continuation and strength below the 200SMA is concerning from a strategic perspective, there is also an oversold reading on the daily RSI that coincides with price testing its most recent support from August 2016.

Seeing oversold or overbought levels on multiple timeframes can usually provide a reliable indication of a reversal of trend or countertrend move in the near term.

EURUSD

Elsewhere, EURUSD paints an even more concerning picture for USD.

For instance, the monthly chart displays how EURUSD broke out of the price range that it has been forming since the beginning of 2015. Moreover, positive divergence between monthly RSI and monthly MACD imply underlying price strength.

The weekly EURUSD chart provides a closer look at the trading range formed over the past two and a half years. Not only was the price breakout swift to move through prior resistance around 1.14 but the underlying trend strength, measured by the Average Directional Movement (ADX), is robust as well.

ADX measures the strength of a trend independent of its direction. That is, the higher its value the stronger the trend and vice-versa. Based on some of Welles Wilder’s original work, an ADX value over 25 represents a strongly trending market. Additionally, the difference between the Plus Direction Indicator (+DI) and the Minus Direction Indicator (-DI) explains the current price direction.

In the case of weekly EURUSD, we see that +DI is over -DI with ADX over 25 indicating that price has built a strong uptrend.

The daily EURUSD offers a mirror image of the USD index.

In particular, we can see price is well above its 200SMA. Also, the slope of the 200SMA is now beginning to turn up which can indicate a positive price trend underway from a long-term perspective.

If EURUSD is going to experience a pull back after this breakout then previous resistance, now turned support, around 1.13 or even the 200SMA may provide support and a strategic opportunity to get long.

Key Takeaway

Given the strength of the move down in USD and up in EURUSD coupled with USD hovering around a multi-year support zone, traders should look for a reactionary, countertrend rally and pullback in USD and EURUSD, respectively. This would allow for each currency to work off its extended conditions before possibly building new, primary trends.

John DiRico is a trading and investment professional focused on technical analysis as well as alternative investment strategies. Additionally, he is the founder of the blog “A Discounted View” where he offers his observations on markets based on industry experience and topics covered in the Chartered Market Technician (CMT) curriculum. Please feel free to connect.