A Week of Huge Key Reversals (And Their Implications)
Over the last several months (since the depth of the pandemic), we've seen some huge rallies in gold. We've seen some huge rallies in the stock market. And we've seen a tremendous selloff in the US dollar too.
But based on what we saw last week, I think we’re about to take a breather from these very robust trends. Today I’ll unpack each asset class, explain my thoughts and show you what I see going forward.
Let’s start with the dollar, as measured by the US Dollar Index (USDI).
The dollar peaked at the height of the pandemic at a major resistance area and then established a bearish head and shoulders price pattern. USDI broke through the neckline of this pattern just a few short weeks ago, suggesting that bearish pattern will shape the direction of the market over time.
But that was then, and this is now. No market moves in a straight line forever.
USDI made a bullish key reversal last week. (That’s a bar where the market sinks to new lows, then closes at or near the high (meaning the buyers were in control).
Because of that key reversal, I feel USDI is likely to find support for the immediate future. It will likely rise to the neckline of the head and shoulders pattern and re-test it.
At that point we’ll see how long it takes before support for USDI evaporates and the descent resumes. That will likely take a couple of weeks … or potentially longer, considering we’re not that far away from a US Presidential election and all the uncertainty that can bring to the table.
Now here’s EURUSD (the Euro versus the US dollar):
Basically this is the upside-down version of USDI because the Euro comprises over 60% of that Index. And since the dollar is getting some support, we can also expect some resistance in EURUSD.
And that's what we're seeing with a collection of bearish key reversals at the 1.20 price level.
Each time EURUSD attempted to go north of 1.20, the sellers were in control again by the end of the week. I don't feel that EURUSD will undergo a dramatic selloff here, but I can well imagine it could trade sideways and even drop somewhat before picking another (likely upward) direction later this year.
For another example of how a strengthening dollar is affecting the market, one of the stronger currency pairs in the last three to four months has been AUDUSD (the Australian dollar versus the US dollar).
Last week, AUDUSD hit a pocket of resistance at the 0.74 price level which is consistent with past resistance. It traced out a weekly bearish key reversal too, which shows us that by the end of the week, the sellers were in control.
Looking at AUDUSD’s long-term downtrend, the price peeked above it temporarily. Then the key reversal was completed. So I foresee that AUDUSD prices will settle back somewhat over the next couple of weeks. Whether it's a dramatic setback or just a consolidation is yet to be seen.
Now I'm going to look at the JPY (Japanese yen) correlated trading pairs, starting with USDJPY (the US dollar versus the Japanese yen).
As long-time readers know, I've been firmly in the bear camp for quite some time in USDJPY:
I remain a USDJPY bear because of the dominant, governing price patterns going all the way back to 2015. Those patterns include the double top at 126 which formed the head of a head and shoulders pattern.
The market has since traced out a descending triangle and a second head and shoulders with a double top within that triangle.
But so far USDJPY has been stubborn about continuing to confirm that bearishness. Most recently, it has formed a coil from which it could break in either direction. I’m not ruling out that USDJPY could break out of the recent coil and re-test the upside of the descending triangle before dropping again.
Or perhaps it will simply drop first.
It’s impossible to tell yet. For now, just understand that coils usually precede a burst in price action one way or another.
So we’re at an inflection here and in the other yen-correlated pairs too. The good news is that we're getting closer and closer to a resolution and some excellent risk/reward trade opportunities in the not-too-distant future.
Here’s GBPJPY (the British pound versus the Japanese yen) as another future trade possibility:
GBPJPY is getting closer to realizing a “moment of truth” about its future direction. Either it’s going to keep going higher (and that momentum will feed on itself and generate higher and higher highs) …
… or it falters, in which case there's a very good chance that it’s going lower -- fast.
Either way I believe we’re very close to a resolution here.
A drop seems more likely than a rise if you look at the bearish governing patterns, which include a very prominent double top at the 195 level as part of a head and shoulders.
The market has continued to act bearishly with a large rounding top. Within that top, the market has traced out a complex head and shoulders pattern. (That’s when there are multiple shoulders on each side of a higher central top acting as the head.)
GBPJPY is now at a juncture where if it breaks above this rounding top, it would represent a major trend change for the pair.
But instead there was a subtle key reversal last week. The price closed a hair closer to the low end of the weekly bar. It’s not a complete reversal, but given the governing patterns, it's my expectation that GBPJPY will drop back and retest 137. If it punctures that new uptrend line, then that should trigger a slide in the primary direction (down).
For now, I'm going to let the market be the ultimate referee. I'm drawing my structures around the price action, and I’m waiting to see how the market behaves within those structures.
As with USDJPY and GBPJPY, there have also been bearish governing price patterns in EURJPY (the Euro against the Japanese yen):
Yet another head and shoulders patterns has been guiding the bearish price action here for some time.
Despite that, EURJPY has had some recent upward momentum. Can that continue with EURJPY busting above its long-term downtrend line?
Perhaps. But last week was a bit of a setback for the bullish case when a bearish key reversal appeared. Will it start a downhill slide or just a period of consolidation between 125 and 128?
Right now it’s an open question. There are opposing patterns: two double bottoms including the one that EURJPY is currently rising from.
This second double bottom might act as a launchpad to turn around a bearish market, but so far that hasn’t happened yet. Instead EURJPY continues to coil and build energy for an explosive move.
Which way EURJPY comes out of the coil could be decisive.
I don't think we're going to have to wait too long for the market to give us some guidance as to which way this is likely to break.
Now for a pair I haven’t discussed for a while: AUDCAD (the Australian dollar versus the Canadian dollar).
AUDCAD has had a magnificent run over the last four months, but by now the momentum is starting to fail. We’re likely to see a pullback now, which would continue what has been a subtle but long-term downtrend marked with a complex head & shoulders.
At best, AUDCAD will consolidate here as it prepares for another launch higher. Otherwise it seems likely to back off from formidable resistance and drop lower in the near future.
Another pair that I'm watching closely is GBPAUD (the British pound versus the Australian dollar).
As with most every pair these days, there's some ambivalence as to which way this is going to break out. However, always note the governing price pattern to determine the existing trend. That allows you to see the bigger picture, understand what would constitute a change in trend, and place your bets in favor of the trend or against it.
Here in GBPAUD, the governing pattern is a triple bottom formed many years ago. There were several attempts to retest the neckline of that pattern.
Recently it dropped again before tracing out a key reversal at 1.75. I think this level should hold and GBPAUD is ultimately going to find a bottom here. It might very well re-test 1.75 again first, but the way this market is coiling up, combined with the bullish price history, suggests the breakout will be to the upside.
The way to play such a scenario is to place a buy stop just above the coil (your stop loss should be just below the coil). If prices run up, you'll be taken along for the ride. It may take a couple of weeks for this to materialize, however. Just be patient and use a small position size for safety.
Another currency I'm keeping my eye on is the Swiss franc.
The franc has historically been strong against most currencies across the board, but I'm starting to see what could turn into a short covering rally. Here’s GBPCHF (the British pound versus the Swiss franc):
GBPCHF has been in a major downtrend, but I'm starting to see the potential for a rally after the pair recently made a new bottom.
That sharp spike downward may have created a bear trap for anyone who chased the lower prices. What’s more, GBPCHF has been in a steady uptrend after re-testing support a few weeks ago.
It could be the start of a short covering phenomenon with higher lows and higher highs. If GBPCHF keeps finding a way to not go lower, there could be a surprisingly sharp rally to come.
I think the risk/reward is acceptable.
Start building a position and who knows -- out of nowhere, you could be rewarded very quickly with the kind of move that most market observers aren’t expecting.
Now for precious metals, starting with XAGUSD (spot silver):
Silver broke out above a seven year downtrend line on the back of a very bullish inverted head and shoulders. As silver began to rise above the neckline of that pattern, I alerted my members to pile into silver around $18.47 with an arbitrary take profit at $25 87.
That resulted in a nice 750 pip gain. After I got out the market did go slightly higher, but I’ve been cautioning traders for some time that this is where discipline really comes into play. When it looks like the whole world is piling into something, and there’s a huge expansion in volatility (we’ve seen silver expand to $4 and $6 ranges in a week), it’s a danger sign.
Whenever I see at least three bars of expansion of higher volatility, as happened here, it’s time to hand over the reins to another trader with a higher risk tolerance. Yes, I might miss another move higher, but experience has taught me that chasing these things never ends well.
The danger increased when silver made a huge key reversal last week. After rising to $29, it closed on the low of the week and the sellers were in control.
It’s yet to be determined if this is going to be a constructive consolidation in an ascending market or if we’re about to see a cataclysmic selloff, but right now I’m in the bear camp. However, the risks in such a trade are very high because the large ranges make it difficult to control your stop loss and therefore your money at risk.
If you’re inclined to trade silver right now (or gold, for that matter) trade a far smaller position size and set your stops wider.
I continue to look for a further opportunity to the downside, as the run up in this metal seems to be somewhat exhausted at the moment.
Let’s look at XAUUSD (spot gold) for comparison, although my conclusions for the yellow metal are much the same as for silver:
Since making an all-time high four or five weeks ago, gold has made a series of lower highs. The rally that began in earnest in January looks like it's stalling.
Gold is forming a symmetrical triangle, which is a neutral pattern. It can continue to the upside or it can reverse to the downside. I’m betting it will be the latter because the expansion in volatility is such that it has made me very cautious.
That’s why I advised my Elite lead members and those in my Gold Program to get short at $1,962 last week. We're trading about 400 pips lower so far. I think there’s more to come thanks to the key reversal gold traced out last week. To my mind, this suggests lower prices in gold.
If we get a rally from here, I’d be inclined to take the short side as I think gold is going to retest the $1,750 to $1,800 price level before this reversal is done.
Now for the drama in the stock market …
Just when it looked like trees were going to grow to the sky, there was a huge setback in the NASDAQ last week. Broadly, the NASDAQ stock index has been trading within the confines of an ascending broadening price pattern:
The price did break out several weeks ago, but it now looks like it’s going to re-enter the confines of that ascending broadening price pattern. This was a huge reversal.
This market has been buoyed by a Federal Reserve that has stood ready to infuse whatever stimulus it required, including the negative interest rate phenomenon where investors could not get a return anywhere else.
That’s why markets have been chasing this asset class to the sky, but this new, huge reversal has forced a reality check. The NASDAQ could fall 10% or even 15% before an extended period of consolidation.
After all, it’s not out of the ordinary for the stock market to go through phases of consolidation, especially after a huge run. Look at the long period of historical consolidation I highlighted on the chart: there are definite time periods where the market can simply tread water for years.
I wouldn’t be surprised to see something like that happen again.
The S&P 500 made a new high last week before selling off hard.
This index has been trading within the confines of a large reverse symmetrical triangle. It was right at a major resistance level I've been warning about for the last couple of weeks. The S&P500 edged past it by a hair, but now you can see how reality has set in with a giant reversal.
The current pattern could also be viewed as a megaphone top. It looks just like a megaphone that a coach (or a cheerleader) would yell through on the sidelines.
And if that’s the case (that this is in fact a topping pattern), this key reversal could portend a dramatic decline to the bottom of the megaphone. (I'm not saying this will happen, I’m just pointing out the possibilities.)
The key takeaway is that recent price action strongly suggests the S&P500 just hit a substantial inflection point and that we’re unlikely to see new highs for quite some time.
Now let’s take a look at DJIA (the Dow Jones Industrial Average):
While the S&P and the NASDAQ surpassed their earlier yearly highs, the DJIA was not able to follow suit.
So we have a non-confirmation where only two of the three indexes made a new high.
And again, just like the S&P was trading within the confines of a large symmetrical triangle, the DJIA has been doing the same. It too traced out what looks to be a devastating reversal right at a resistance area.
I expect that will set in motion a price decline over the next couple of weeks.
And that’s it for the week!
Remember we have less than 60 days to the US election and it’s likely we’ll see all kinds of noise and volatility in the markets. Be prepared to take control of your portfolio accordingly.
To summarize, the US dollar should stabilize for the short term. Other currencies are also likely to consolidate. I expect consolidation in the precious metals as well, and perhaps a stronger drop in the US stock markets.
In the meantime, I’m keeping my eyes open for what the yen pairs are poised to do. I'm sure that good risk/reward opportunities are going to present themselves sooner rather than later.
So keep your powder dry for now. Let’s just wait and see how the market plays out.
I wish you a very healthy and prosperous trading week.
Mark "StockMarketFreeRide" Shawzin