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Dollar Weakness Ahead: How To Play It

Mark Shawzin
October 14, 2020

Let’s cut to the chase and say the dollar has been weakening over the last couple of weeks. What’s more, it’s likely to keep weakening over the next days, weeks, months and possibly years.

In this chart, I'm looking at USDI (the US Dollar Index) which tracks the US dollar against a half dozen major, liquid currencies.

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This is a weekly chart, which means each price bar represents one week in time.

And we can see that USDI has traced out what looks like to be an enormous double top price pattern, one where the second top forms the head of a head and shoulders price pattern. Both patterns are bearish and both are reversal patterns.

That strongly suggests USDI is likely to keep weakening. Look to establish short positions with wide stops as soon as possible.

So why am I bearish this week, after warning of a USDI price rise recently?

You might recall that a couple weeks ago, USDI made a bullish key reversal. The price hit a new low and then closed at the high that week. I said USDI was likely to rise and retest the neckline of the head and shoulders. That’s now been accomplished.

Along the way, USDI has formed what I call a coil: two or more bars where the ranges from highs to lows sit within the range of the bar three weeks ago.

A coil is where the market builds up energy. Then you look at the prior pattern or price action to anticipate where energy is most likely to be unleashed.

Based on the double top and the head and shoulders, this coil is likely to unleash its stored energy in a bearish direction.

It won’t happen all at once of course. There’s a bit of price history to go through first — typically markets don't cut through prior support (or resistance) right away. So I’d expect some volatility at or near current levels.

But do look at getting short the US dollar across the board.

There are a couple of pairs I strongly favor against the U S dollar right now…

The number one pair on my ‘short the dollar’ hit parade is AUDUSD (the Australian dollar versus the US dollar):

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Over the long term, AUDUSD held at the 0.66 – 0.67 price level until the height the pandemic. Then it plunged below that support level before rebounding sharply.

That plunge now looks like a giant bear trap (or short squeeze) which eventually turned out to be the head of a bullish inverted head and shoulders reversal pattern.

Since the right shoulder is higher than the left, this creates a sloping neckline when we connect the whole pattern.  The upsloping neckline suggests AUDUSD could rise very quickly once it hits and clears the 0.75 price level.

Once AUDUSD clears that hurdle, the next big objective is around 0.80 – that’s 500 pips higher.

That creates a great risk/reward trade if you go long AUDUSD this week.

There’s also a recent coil formed here, one quite similar to USDI. AUDUSD should explode out of this coil when you consider the bullishness of an inverted head and shoulders with a sloping neckline.

Picture a beach ball, one where you’ve pushed it underwater harder and harder until suddenly you lift your hand off.

I think AUDUSD will rise in pretty much the same way.

There could be some turbulence at 0.74, but keep your stops wide and look at the long-term when establishing long position here.

Next on my favorite pairs to play against the US dollar is GBPUSD (the British pound versus the US dollar).

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There's been a lot of hubbub and turmoil about the British pound lately because of the UK’s increased number of COVID incidences and also increased Brexit concerns.

But it’s generally my position that the market is ahead of the news. If you're looking directly at the news, you can’t determine market direction. And right now I think any GBP bearishness is a case of perception versus reality. There’s a pretty negative perception in the UK at the moment, but the markets are already looking ahead of the immediate timeframe.

Here’s what I’m seeing to support that: GBPUSD is an emerging Eve and Adam double bottom. The Eve bottom involves multiple pokes at a similar low and an Adam bottom is only a single poke.

A double bottom is a reversal pattern and this is a big one. The neckline is at 1.35 and right now GBPUSD is trading 400 – 500 pips below that. A rise to that neckline would confirm this Eve and Adam double bottom and that in turn would create an enormous base for a pivot higher in GBPUSD.

Most recently, GBPUSD has been hugging an uptrend line. And there’s yet another coil forming in the last few weeks.

It looks like GBPUSD is on a trajectory higher toward the 1.35 resistance level right now. It could move very quickly.

Now here’s USDJPY (the US dollar versus the Japanese yen):

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This chart looks extremely bearish but I'm going to abstain from trading USDJPY unless I see certain price action.

To my mind this is a very bearish chart, starting with a double top that proved to be the head of a head and shoulders pattern which set the tone of this chart way back in 2015. Bearish price action is by and large what we've seen since that governing price pattern occurred.

More recently, USDJPY contained within the confines of a descending triangle. That’s also bearish, but this could take many more weeks to play out. It's even conceivable USDJPY might jump to the trendline of the triangle.

That’s because prices have been contained pretty well at the 104 level lately. There seems to be some support here, complete with bullish key reversals.  So it’s likely to be difficult for USDJPY to get through the 104 level at this time.

For now, I will continue to monitor the price action here.

Remember that the market is always right in the end. I put a structure around prices and then I monitor the price action within those structures.

So if USDJPY takes a sudden dive, I’d be inclined to feel it will go much lower. However, price action is instead suggesting there will be continued support in USDJPY for the next few weeks.

Another structure to watch is the trendline USDJPY has been hugging. If USDJPY can break out past that, such price action could launch it toward the 108 level.

So despite my inherent bearishness on this pair, I'm not inclined to play USDJPY right now. I just want to show you what I'm thinking as we wait for the market to give us a better clue on the next major move here.

That doesn’t mean all yen pairs are alike, though.

Here’s GBPJPY (the British pound versus the Japanese yen):

As with USDJPY, this pair established a governing pattern many years ago. (This is the value of looking at long-term charts. The bearish price patterns in GBPJPY have basically governed prices for many months and years.)

Following the formation of a head and shoulders with a double top acting as the head, GBPJPY dropped from 175 all the way to 120.

Since then, GBPJPY has been contained within a rounding top. Every time this pair has rallied, it had a huge sell-off. Now it’s trying again.

So does GBPJPY go lower this time too? Or is this going to be an inflection point and a major turnaround in the market?

I believe the momentum in GBPJPY remains on the upside. GBPJPY has been hugging a support line and I expect that to continue until we hit at least the 141 – 142 level where it will encounter resistance.

So there’s definitely more pips on the table here if you’re already long or thinking about going long.

Again, I always look at potential patterns that could reverse an existing trend (this is how to catch reversals before anyone else). We might have another Eve and Adam double bottom here, which I especially like since the Adam bottom was during the height of the pandemic when hysteria was at its wildest.

That seems to have created a giant bear trap and short squeeze similar to AUDUSD.

So I'm getting the feeling that GBPJPY is going higher for now, even if it remains to be seen if the long-term downtrend is truly finished.

Now onto yet another GBP-related pair …

Those of you who have known me for any period of time will remember that I’ve steadfastly held to the concept of a stealth bull trend in GBPNZD (the British pound versus New Zealand dollar):

The double bottom all the way back in 2016 – 2017 was the governing pattern here. Once that double bottom was confirmed with a breakthrough the neckline, GBPNZD has risen in a steady but very volatile uptrend.

That volatility can often pose a problem for us as traders, of course. This pair has tremendous price ranges as wide as 200 - 300 pips. Unfortunately, I've been stopped out on some of these trades because of the huge volatility. But if you keep your eye on the goal here, you’ll understand what's going on.

I firmly believe GBPNZD will find a way to go higher again. So even though it made a new high and then fell back during the week, this looks to be nothing more than a move to shake out the weak hands.

In fact, there’s another Eve and Adam double bottom emerging here. This won’t be confirmed until GBPNZD clears the 2.03 level. But I have a feeling this pair is headed higher.

It’s been tracking alone a trendline, and every time GBPNZD hit that line it’s bounced.

When it hit 1.90, I said it was likely to be a low that will hold. And by and large, we are 500 pips higher today. GBPNZD should go much higher yet, albeit with a lot of volatility.

So if you're inclined to go long GBPNZD, understand that putting a 15 pip or 37 pip stop is just not going to work. There are 200 - 300 pip daily ranges in this pair. Put on a smaller position size with a much wider stop.

Perhaps once or if we get to 2.03 you can get more aggressive with tighter stops. But for now, be careful of the volatility.

In this chart, I'm looking at XAGUSD (spot silver).

Over the long term, silver broke out above a seven-year downtrend line while also breaking the neckline of an inverted head and shoulders pattern (just like AUDUSD, but with a normal, flat neckline).

For many, many years silver suffered through a huge decline from $50 all the way to $11. However, an inverted head and shoulders is a bullish price pattern and helped silver finally break that long decline.

Silver recently corrected from that huge breakout.  I thought it might go all the way back down to $20, but by virtue of last week’s price action, it looks like silver has fallen to its maximum extent.

At this point, I feel silver will once again head higher.

Note the inside bar coil where for the last couple of weeks, silver prices have been contained within the range from three weeks ago. If you’re inclined to play a potential rise here, beware of the renewed high volatility. That means taking a much smaller position with wider stops.

But it does feel like the path of least resistance is higher once again. Obviously, silver has to clear a lot of price history, but it should happen.

Another key point is that silver is correlated with the dollar. Since the dollar is projected to go lower, this means XAGUSD is inclined to go higher.

Now here’s XAUUSD (spot gold):

A couple weeks ago I noticed a big symmetrical triangle was forming and alerted members to short gold at the breakout of that symmetrical triangle. We got short around $1,912 with a first target of $1,850.

That $1,850 was the low of the triangle and therefore a level of prior support. This time it held again.

Now gold is once again testing the breakdown level of the symmetrical triangle. Typically if markets are bearish they'll rise to retest the breakout area before dropping once again. USDI is a good example of that phenomenon.

While that’s possible with gold, I'm getting the feeling that such a drop is not going to happen here.

There’s another coil with two inside week bars inside the high and low of the bar from three weeks ago. That coil is storing energy for a further release and by virtue of gold’s long-term uptrend, I surmise that energy release is going to be higher.

This too is likely to be volatile. Buy gold with a wide stop if you’re ready to play this anticipated rise.

Another bullish point for gold: the channel it’s been building. Gold definitely looks ready to take another shot to the upside. And don’t forget XAUUSD is correlated to the US dollar. XAUUSD will rise on US dollar weakness.

I'm going to finish off this week by looking at the NASDAQ stock index:

This index has been in a turbocharged uptrend since the depth of the pandemic. The trend was launched by a huge key reversal which coincided with a long-term uptrend line.

And now the path of least resistance appears to be higher … for now. I think the NASDAQ will retest its earlier high. Then we'll see how it goes. Obviously, the parabolic nature of the NASDAQ’s rise means it has to end sometime. And for sure we’ll see a lot of volatility.

But for now, the path of least resistance is higher. I would not get in front of this index and short it yet. There’s still plenty of energy that could be released to the upside. Only consider a short once price reaches the previous high, and only after examining the price action at that time.

And that’s it for the week!

To summarize: I’m bearish on the US dollar now that its rally appears to have peaked and therefore I’m bullish on AUDUSD and GBPUSD. I’m also bullish on GBPJPY but don’t recommend anything but watching USDJPY for now. It’s okay to go long silver and gold, but be careful of the volatility.

I wish you a very healthy and prosperous trading week.

Mark "DollarCrush" Shawzin