How to Distinguish the Difference Between Two Practically Identical Patterns and the “Violent Pair” That Are About to Rocket in Price
Previously I’ve highlighted that the U.S. dollar has been looking quite bullish lately. That trend has looked much stronger this week, so let’s take a look at first the dollar itself and then the FX pairs most likely to generate short- and long-term profits from that strength.
The U.S. Dollar Index (USDI) tracks the dollar against a half dozen major currency pairs:
As you can see, USDI has been in an uptrend for many years. Its long-term support line was tested with a double bottom recently and the price responded very bullishly.
Now USDI has just cracked through the neckline of the double bottom and then through a recent resistance area too. That means there’s lots more open space above and beyond for USDI. I think prices will continue heading higher, especially against the Euro, the Australian dollar and the New Zealand dollar.
So even though there was a time where USDI appeared to be trapped at a resistance area and ready to roll over, the anticipated bearish market action never followed through. Instead USDI has grabbed a foothold and is building momentum for yet another upward leg in the U.S. dollar bull market.
Let’s see how this newfound dollar strength affects EURUSD (the Euro versus the U.S. dollar).
Over the past 10 years, EURUSD has dropped from 1.70 to under 1.10. I don't see anything in the near term that’s going to stop this downtrend. The one rally EURUSD made was snuffed out by an interim double top. Once the price broke down through the neckline of that double top, EURUSD has only ground lower still.
EURUSD has effectively hugged the boundaries of a downtrending channel and now looks to be on a collision course to retest the lows at 1.08 and potentially much lower than that.
As the U.S. is entering a rather political season, it’s hard to tell when EURUSD will truly gain momentum. But the ultimate direction looks clear: look out below.
Just remember that there’s previous price history in a given area (such as plenty of historic support between 1.04 and 1.08), which will make for a bumpy ride as EURUSD works its way lower.
Ultimately I see EURUSD as being on track for parity (1:1) with the U.S. dollar. I don’t know the timing of it thanks to this being an election year in the U.S., but lower prices are definitely on the way for this pair.
The same can be said for AUDUSD (the Australian dollar versus the U.S. dollar). I've consistently said over the last couple of years that the Australian dollar is inherently weak and it does look poised to drop further at any time.
As with EURUSD, AUDUSD has been in a protracted downtrend. While AUDUSD appeared to make what could have been a double bottom a few months ago, subsequent price action failed to follow through. The governing pattern remains the double top which confirmed the long-term downtrend.
I don't see anything on the horizon to turn AUDUSD around. The pair looks set to make multi-year lows.
That means every bounce in AUDUSD should be shorted.
NZDUSD (the New Zealand dollar versus the U.S. dollar) is more than just a geographical cousin to AUDUSD. The charts are also very strongly related and you can draw much the same bearish conclusions about NZDUSD’s future.
There’s a long-term downtrend. A governing pattern in the form of a double top (or a head and shoulders, if you will). And then a return to the downtrend once NZDUSD cracked that pattern’s neckline at 0.68.
There was a recent bounce all the way back up to 0.68 until historical resistance reappeared. Because NZDUSD couldn’t break out against that resistance and struggled to yet another lower high, this confirmed the double top / head & shoulders has remained the governing pattern.
I didn’t take the little double bottom that launched this bounce, by the way. Sometimes I do, but not that one.
Such counter-trend trades can be profitable as long as you understand they’re usually just short-term reversals against the longer-term trend. You need to adjust your profit target accordingly.
To clarify this point, let’s take a closer look at how to look for patterns and distinguish a dominant governing pattern from one that turns out to be little more than a short-term distraction.
(People always ask me if I look at the daily charts or the weekly charts. As you can see, I look at both.)
On this daily chart, you can see that back in October 2019, NZDUSD made clear inverted head and shoulders. This was very bullish, as there’s a clear head (a double bottom) and a shoulder on each side.
When you see a pattern as well-defined as that, it’s entirely possible to take a nice couple of hundred pips from a countertrend trade. However, this pattern was more of a fake out than a reliable countertrend signal in my mind. So I stayed out because of the long-term downtrend already in place.
If you do take such trades, remember that going against the trend isn’t very sustainable. They usually end pretty quickly and this one is a good example.
Let’s say I did take this bullish trade. If I had done so, I would have exited when the bearish head and shoulders formed. That’s when you know a move is definitely over: a clear pattern forms to oppose it.
As you can see, the counter-trend rally got cut short very quickly and didn’t offer a lot of profit potential.
That’s why going with the trend is so much better. As soon as the bearish head and shoulders formed, I advised Elite members to go short.
Not only was there a strong head and shoulders, this pattern confirmed the overall bearish trend and was, therefore, a safer, longer-term trade.
I hope that clears up why I’m more confident about certain patterns over others. It has everything to do with the existing trends and the dominant patterns in support of them.
Now let’s examine USDJPY (the U.S. dollar versus the Japanese yen) as another tutorial to help you determine which are governing patterns and which are just short-term price action.
You can see that in the short term USDJPY has been adhering to a support line and forming a small uptrending channel.
The continued resilience of USDJPY has been a bit frustrating as I’m still bearish on this pair based on the governing pattern which remains the head & shoulders to the left of the chart.
That head and shoulders combined with the descending triangle (meaning a series of lower highs linked by a common low) strongly suggests the long-term trend in USDJPY remains down.
What would change my mind? If USDJPY can bust out of the triangle and make new highs, that will give me some strong evidence that USDJPY is no longer in a bear market.
But until my bearish expectations are proven wrong by the price action, I must remain bearish. That doesn’t mean I have to maintain a short position though. I abandoned my short positions last week for a small profit as USDJPY rallied.
Now I’m waiting to see how the price action proceeds. Can USDJPY break out of the triangle?
I’m willing to change my mind if it can do so. But until then, USDJPY is still traveling within the bearish descending triangle and I’m just waiting for another and better opportunity to go short once again.
I haven’t taken a long position here because there are no bullish patterns to support it. Some people have asked me if there’s a triple bottom in USDJPY, but my answer remains no. That’s because the series of lower highs doesn’t suggest that there’s a bottom … yet.
On the topic of dominant patters, let’s take a quick look at GBPNZD (the pound versus New Zealand dollar) too:
This has been a difficult pair to trade, but I keep my eye on the ball by identifying the governing pattern and staying with the overall trend. That way, whenever the price gets into a bumpy territory (like now), it’s so much easier to hold winning positions.
The governing pattern here is the double bottom with the neckline at 1.80. This neckline subsequently became support for another double bottom.
So even though GBPNZD is down 500 pips from the highs last week, it’s still not far from multi-year highs and hasn’t violated any key support levels. That’s how you keep these trades in perspective. On a 15-minute chart, a 500 pip downdraft looks very scary. Yet it’s just a minor blip in what has been a slow, steady bull market in GBPNZD.
Because the price has failed to make new highs recently, does that mean this pair is tracing out a triple top? To my mind, there's nothing to suggest that yet. Time will tell, but I don't think it will happen because the price action would have to drop below recent support levels and look much more bearish than it does now.
This really is a violent pair, no doubt about it. It will continue to make wild swings.
But the governing bullish pattern remains dominant and that’s why I continue to hold my long positions with the view that even with some volatility, GBPNZD will work its way higher over time.
Now for the precious metals …
In this chart, I'm looking at XAGUSD (spot silver) and again, this is a chart that demonstrates the importance of determining which pattern is dominant and which is the fake-out.
Now, recently we had a whole bunch of excitement in silver. We had what looks like a double bottom followed by a small breakout. The price launched from $16 to almost $20. There was a war in the background, there was a trade war with China, there was a lot of emotions rampant in this market too.
But don’t chase sentiment. Just look at price action. To my mind, the recent rally is nothing more than a bear market rally where historically we’ve seen nothing but lower highs for years now.
If a market is going to turn around for real, it needs to start making new highs. I'm not ruling out that silver could come out of nowhere and do exactly that. If it does, I’ll certainly start paying attention.
But the dominant trend in silver has been lower. There hasn’t been any real follow-through to the rallies of the $14 lows. Even the most recent rally is starting to look like a double top.
If silver takes out its recent lows at the neckline around $16, this would establish the double top as another governing pattern in a primary downtrend. The next stop would be $14 once again.
That’s why I’m still not a silver bull. There’s no price action in the market to change my bearish stance yet.
Despite all the recent excitement, we still haven't seen any real breakout. Until that happens, silver’s path of least resistance is still lower.
XAUUSD (spot gold) looks very different than silver because you can see that at some point gold did break out and start making higher highs.
The historical gold-silver ratio (the price of gold divided by the price of silver) has been around 50. Recently that ratio reached a historical high around 94.
The long history of this ratio suggests that ultimately, silver is likely to drag the price of gold lower.
But just because silver may be going nowhere (or lower) doesn’t mean that gold can't go higher for a bit longer. I'm just wondering how much is left in the current gold rally.
I don't see gold’s current pattern as a classic top and to my mind, the path of least resistance is still somewhat higher. However, I’m watching gold very carefully while I sit on the fence and see whether silver’s bearishness or gold’s bullishness will win out here.
I do want to point out that just because silver looks one way, I don't make decisions on gold based on silver. After all, some people will trade the Canadian dollar if oil is doing a certain thing. But I don't really believe in that. You really need to look at each trade on its own merits.
That’s why I look at each trade for a setup I can understand and which offers a good risk-reward potential. Right now I don’t see such a trade as gold. The yellow metal is in somewhat of a nebulous and murky area at the moment and needs more time before I can hop aboard a long or short trade.
This is a chart of the NASDAQ stock index.
The NASDAQ has been a rocket ship higher as it’s adhered to a very narrow trend line since breaking out from an area of stagnation several months ago.
Take note that this has been a very orderly rally. The price bars have been very small until very recently.
Now you can see the volatility is starting to expand. It's still much too early to predict the end of the rally or a meaningful top. But historically, higher volatility indicates a market reversal.
Personally I like to get into the market when there's a low level of speculation, a low level of volatility. Then I start exiting my positions when the volatility begins to increase (a good example would be Tesla which became very, very volatile in recent weeks).
While it's early to start actively shorting this market, it’s likely to retreat to the support line of the channel at some point. That’s likely the worst-case scenario, as the path of least resistance is still higher.
At some point, the trajectory must slow down and we’ll see the NASDAQ enter some phase of consolidation (perhaps as we close in on the U.S. elections). But for now, this market remains a freight train.
And that’s it for this week!
To summarize, I’m bullish on the U.S. dollar, especially against the Euro, Australian dollar and New Zealand dollar. The U.S. stock markets remain unstoppable and unshortable.
I remain bearish on USDJPY and silver, bullish on GBPNZD and neutral to bullish on gold.
I wish you a very healthy and prosperous trading week.
Mark "USDBullTrend" Shawzin