What Impact is the UK Leaving Europe on Friday Going to Have on All Associated Currencies?
Before I dig into the markets, I want to give a shout out to the winner of our recent “Trading Journey” contest. We sent out a request for people to send in the story about their personal trading journey.
We planned to award a single five-year Elite Pattern Trader membership worth $20,000 for the most compelling and powerful story. The response was tremendous. In fact, we received well over 100 submissions.
So I want to thank everyone who participated. It was very difficult to pick a winner as the quality of the entries was so high. As you can see, we decided to award not just one prize but three prizes including two runner ups.
The winner of the most compelling trading journey was Steve Shadden. A big shout out to you Steve! Thank you again for sharing. Steve gets a five-year Elite Pattern Trader membership worth $20,000.
Other powerful stories included Vance Gibson and Frank Wilmink. We decided to award both traders a free year of Elite Pattern Trader membership worth $10,000 each. So thank you for guys for telling your stories and thank you, everyone, else for participating.
Now let’s take a look at the markets.
For most of January, I've stayed in capital preservation mode. I’ve mostly been sitting on the sidelines waiting for the market to give me a better indication of where it’s going next.
The U.S. Dollar Index chart USDI) is a good example of this as the dollar has been jammed up in a trading range for quite some time.
That state of affairs describes a lot of other markets right now too.
Fortunately, I think we're getting closer to identifying some very good high probability trades.
You can see from the chart that USDI has risen for the last several years. At this juncture last year I was unsure whether USDI’s current level represented a major resistant resistance area where the dollar was going to roll over.
You could say I was tentatively bearish.
But whenever I draw a structure, I observe how the market behaves afterward. I look for a follow-through -- in this case a drop from that resistance area.
But USDI hasn’t really done that. Instead, it’s dug in at its long-term support line with a nice double bottom. And right now USDI is resting right at the neckline of that double bottom.
I believe any penetration above the neckline will open up another USDI move to higher levels against the Euro (EUR). Australian dollar (AUD) and the New Zealand dollar (NZD).
Let’s take a look at some of those pairs starting with EURUSD (the Euro against the U S dollar).
This chart backs up what we were seeing in USDI: that the U.S. dollar is likely to go higher. EURUSD been in a huge downtrend from 1.70 about 10 years ago to about 1.10 currently. This downtrend continued in earnest a from the double top continuation pattern. (That double top put an end to any prospective Euro rally.)
Once EURUSD went through that double top’s neckline at 1.15 it was a green light for this market to drop lower.
Now with that said, EURUSD has been marching three steps down and two-and-a-half steps back up. So it's not been easy. However, I don't think there's much risk in staying short.
That’s because EURUSD put another, smaller double top at the 1.12 area. EURUSD is now sitting on the neckline of that pattern. Any penetration below 1.10 should open up a new move lower.
That’s why I’m inclined to short any substantial rallies in this pair going forward.
Now for a chart of AUDUSD (the Australian dollar versus the U.S. dollar).
For the last four years, this pair has been in a steady descent from the 0.95 area to a current level of around 0.68. The primary trend remains down, especially since the double top acted as a continuation pattern.
When AUDUSD penetrated the neckline of that double top at 0.75 it’s fallen ever since. That’s how powerful these patterns can be, just as with EURUSD,
Having said that, at one time it looked like might have AUDUSD had bottomed out with a double bottom. But what separates one pattern from another is the price action after the pattern is formed.
If AUDUSD really had formed a double bottom, you’d expect stronger price action than what we’ve seen. Instead, this pair rose above the neckline, then failed to sustain any momentum. It’s once more dribbling lower.
That’s why you need to distinguish a real pattern from a not so real pattern when examining a given market. That’s why the real patterns here with AUDUSD is that double top followed by the bearish descending triangle.
The series of lower highs united but a common low strongly suggests that AUDUSD will drop to and below its current historic lows over the next several weeks and months. This seems to be another low-risk short when you look at the dominant patterns and the price action.
In this chart, we're looking at GBPUSD (the British pound versus the U S dollar).
As with EURUSD and AUDUSD, GBPUSD is still in a downtrend. The pair now sits at a resistance area at 1.35. The descending triangle suggests the most likely direction is down.
However, this pair is a bit trickier to analyze because the pound is on balance stronger than the Euro and Australian dollar. GBPUSD just isn’t as bearish as the other two we’ve examined so far. I think it’s possible that GBPUSD could slide sideways for a while and go nowhere in no man's land.
That means if you're betting on a dollar rise, GBPUSD is not the best pair to short on the basis of dollar strength.
So how about my long-time favorite short USDJPY (the dollar versus Japanese yen)?
USDJPY is again sizing up for a major opportunity on the short side.
As regular readers know, I've been looking at long-term bear patterns for quite some time. These include the double top forming the head of a head and shoulders pattern at the 126 level as well as the more recent descending triangle. Both these patterns will continue to dictate the future price action and USDJPY should continue going lower over time.
Since a descending triangle is characterized by lower highs over time and a common low (104 in this case), we can reasonably expect USDJPY to return to 104 sooner or later.
Right now USDJPY is at an interesting juncture. While it could still rise to the trendline of the descending triangle, last week’s bearish key reversal suggests this pair has reached a tipping point and prices are ready to head lower. The break above recent highs looks to be a bull trap thanks to that key reversal.
So while I do see the dollar going higher against most other pairs, I think the yen will prove stronger here yet again.
Shorting just below current levels offers a good risk-reward USDJPY trade here, in my opinion. The risk looks to be very limited and the reward could be far greater.
That's what I'm looking for in my trading. We can't always be perfect, but I’m taking a stab at the short side here based on the recent USDJPY price action.
In this chart, I'm looking at XAGUSD (spot silver) on a monthly basis.
Silver is very much still in ‘will it or won’t it?’ mode with regards to breaking out to establish a bull market.
Silver has been stuck in a log jam for the last five years and is currently at a threshold where it could very well break out from its current trading range. There’s a potential double bottom forming and most recently the price consolidation suggests energy is being stored for a powerful move.
However, I'm still skeptical that silver is poised to break out thanks to the long-term price patterns here.
The dominating pattern is the old double top. Since silver broke down below the neckline at $26 it’s been making lower highs. (Just look at AUDUSD and USDJPY earlier in this report for how that works for the bulls.)
I’m waiting for silver to start making higher highs. And yes, the most recent high looked promising.
But I don’t see enough bullish price action yet. That’s why I’m still on the sidelines and waiting for the market to tell me where it wants to go.
Remember, it doesn't usually pay to be the first one through the gate as a trader. I'm happy to let a little bit more price history scroll past before I jump in.
To help you see my (non) position here, good trading markets don’t give you more than a couple of chances to get in before they go. Yet silver has been sitting near its lows since 2014 and we've made multiple lows around the $14 area.
To my mind, if a market's good it shouldn't give you that much time to get in before it puts on a sizeable move. That’s why I’m waiting. I want to see silver break out to new highs before I’m convinced the potential double bottom I’ve drawn is the real deal and silver has turned into a major sustainable market to the upside.
I don't think it will hurt to wait a few more days or even a few more weeks to see what silver does in this price range. Why rush in and fall prey to a bull trap when we have the luxury of waiting to see where the price action takes us?
in this chart, I'm looking at XAUUSD (spot gold).
We can see immediately that gold has been a lot stronger than silver. it's a completely different animal. That’s why I would certainly look to be buying gold before silver.
There’s a double bottom historically. Then gold broke above key resistance at the $1,350 area. After that, it consolidated in a pennant pattern before breaking out again.
That last breakout was quite profitable, by the way. I got into a nice trade where I caught over $120/oz on a breakout from the pennant from $1,479 with a take profit sitting at $1,607. It turned out to be a fairly lucky and terrific trade there. We got out near the very top of what turned out to be a key reversal.
Now gold is digging in again. Despite the large bearish key reversal, we saw a few weeks ago, gold is not behaving in a truly bearish fashion … yet.
But I’m not going long either. I want to see how the market plays at this level. Does gold keep getting stronger? Or does it look like it's going to face some resistance near the highs once again?
If you’re an aggressive trader, don’t let perfection become the enemy of the good. You could take a long trade here and (even if it doesn't work out) it's probably a pretty good risk-reward.
However, I’m prepared to wait a bit longer and see if gold can break out to new highs first.
Now for the last chart of this report, the S&P500 stock index.
For the last several weeks I've been saying that I viewed the 3300 levels as a potential resistance area and it turns out that was pretty close.
While there was a new high last week, the S&P500 did slip back and close on the low. This isn’t a big reversal, though. I don't see this leading to a huge decline. It's a pause and you shouldn't read too much into it. After all, this market has been in an uptrend for a very long time. And most recently it’s been going straight up inside a channel.
The worst-case for the stock market right now is retesting the lower end of the channel at around 3200 and then seeing long-term consolidation for the next few weeks or months.
After all, we've had some consolidation in the FX markets and the stock market is not immune to that phenomenon either.
But I wouldn't put too much expectation on the downside right now. Markets just don't tank on one little reversal. I'd want to see a major reversal with a very long bar before I’d consider that.
And so the path of least resistance is still higher. I would be inclined to buy any selloffs rather than short any resistance right now in the U.S. stock market.
That’s it for this week.
To summarize, I’m bullish on the dollar and therefore bearish on the weaker FX pairs including EURUSD and AUDUSD. I’m bearish on USDJPY because it looks like this pair is destined for another drop despite the dollar’s strength.
I’m on the sidelines with the precious metals for now. And I’m interested in buying short-term weakness in the stock market.
I wish you a very healthy and prosperous trading week.
Mark "USDJPYReLoad" Shawzin