The U.S. dollar index shows signs of bottoming and it’s only a matter of time before it strengthens further. Prices could occasionally have a correction back down to alleviate overbought conditions, but I wouldn’t expect the weakness to last.
A two-week reversal, occurring at the recent low in early December, was one indication the U.S. dollar was about to turn back up. The additional strength seen in the weeks that followed adds validity to this reversal pattern. I anticipate a major low is in place and the trend is turning up now that prices are trading above the down-trending channel.
A two-week reversal indicates a change in trend. On the first day (at a low for the move), the market declines and closes near the low of the week. Prices open unchanged to slightly lower the following week, but fail to make additional downside progress. The decline stalls and prices begin to turn back up, as buying increases early in the week. By the end of the week, the market rallies to around the preceding week’s high and closes at or near that level.
Market psychology: The two-week reversal signifies a turn in sentiment. In the first week the shorts are comfortable and confident. The market’s performance provides encouragement and reinforces the expectation of greater profits.
The second week’s activity is psychologically damaging. It is a complete turnaround from the preceding week and serves to shake the confidence of those who are short the market. The immediate outlook for prices is abruptly put in question. Shorts respond to strengthening prices by buying in order to exit the market. Some shorts buy to take profit and others buy to limit losses.
The accompanying chart also illustrates how the price of the U.S. dollar has risen above the upper boundary of the downtrending channel.
Channels are useful in determining trends and for identifying a change in direction. In a downtrend, the channel’s upper boundary is the downtrend line (line of resistance), and it is drawn first. The lower boundary is the return line. It is drawn parallel across the lows of each progressively lower decline. This line is where prices are likely to bounce off of in a declining market.
Market psychology: Resistance areas materialize, as a market attracts selling up at the line of resistance. A line of resistance is determined by drawing a line across the highs. For a trend line to be both valid and reliable, there should be at least three points of price contact, illustrated as A, B and C in the accompanying chart. Each point coincides with the high of a market reaction.
However, once prices push above the line of resistance, then all recent sellers end up holding losing positions. Consequently, buying increases as shorts liquidate and longs who bought at lower levels add to their profitable positions.
As a new uptrend begins to emerge, buy orders materialize just under the market. This buying supports the market, and when prices stop going down, other buyers jump in for fear of missing the move, and this causes prices to move higher.
Some profit-taking emerges when prices rally to new highs. This results in an increase of potential buyers getting back in when prices move back down. Their buying, as well as that of shorts eager to take profits during periods of downward price corrections, is supportive to prices.
A strengthening U.S. dollar pressures commodity prices, because a higher U.S. dollar diminishes foreign buyers’ purchasing power, which leads to reduced demand and increased stocks.
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David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis in the markets influencing agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit us online at www.ag-chieve.ca/cooperator/for
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