Why We’re on the Cusp of Three Huge Moves [Detailed Breakdown]
I want to begin this week's Report with a long-term view of the U.S. Dollar Index (USDI) to put things in perspective. Then I’ll move onto why I think we're at a historic infection point in the U.S. dollar and which currency pair will benefit the most from a move lower in USDI.
So let’s get started with a 45-year chart of USDI:
Over the last 10 years, USDI has been on a tremendous bull run. On the other hand, USDI is still nowhere near its historic highs. It’s made only a pattern of lower highs instead. This long-term price action has formed a bearish descending triangle.
Today USDI hovers at an inflection point along the trendline of the descending triangle. The price is currently churning at a key level where we could see a breakout (as it exits the confines of the triangle) or a rollover to a lower level (and it confirms the triangle).
It could some time for this to play out. That’s because we’re entering the summer season, which is when we typically see lower volatility in FX pairs.
However, it’s important to understand that we’re on the cusp of a major move in the U.S. dollar. Whether it's a few weeks or a few months from now, we’ll see USDI making a decisive move.
Because of the triangle, I’m bearish and I expect USDI start rolling over and dropping within the triangle at some point this year.
And the one pair that’s ideally positioned to benefit from a move lower in USDI is USDJPY (the U.S. dollar versus the Japanese yen).
Here’s another 45-year chart to help you understand why I feel that way.
First of all, it’s clear that USDJPY has been in a profound downtrend from about 350 yen to the dollar in the 1970s the current level of 107.
What’s more, I don't see any pattern that suggests USDJPY is going to reverse this downtrend. I think USDJPY will break down to new lows at some point. It’s done nothing over the 20-30 years except continue a pattern of lower highs.
I don’t see a double bottom on this chart because while there are two distinct lows in place, USJPY simply hasn’t made any higher highs after the second “bottom”. If this were a real double bottom, you would expect to see higher highs already. Yet that isn’t the case.
If anything, USDJPY is looking weaker and weaker.
So that’s why I expect another leg lower in this pair. I think USDJPY will break hard to the downside.
The only question in my mind is when it will happen. And that means the main risk in this short trade is paying swap fees to the broker as we wait for the position to pay off.
However, time is completely against us here. I’ll show you why with the weekly USDJPY chart:
Not only does everything on the 45-year chart confirm USDJPY is in a profound downtrend, but here at the weekly level, we have every bear pattern imaginable too.
There’s a double top at the 126 level in 2015 which is part of a larger head & shoulders top. (Once USDJPY broke the neckline of that head & shoulders, its been all downhill for this pair.)
The descending triangle since that time is also bearish. Note the similarity to the descending triangle on the 45-year chart of USDI I showed you earlier – this is the same pattern with the same bearish implications. A pattern of lower highs over a common low strongly suggests lower prices are on the way.
The other bearish pattern is the H top that formed in the last few weeks. An H top looks like a capital letter H, and some people have also called this type of top a horn top or a steer top because of its resemblance to a steer’s two horns with the head in between.
You’ve probably noticed that pretty much all these patterns have the word “top” in them.
That’s because all this price action added together has created a formidable confirmation of a bearish future for USDJPY. At best, we could have a market environment where this pair goes sideways. But to my mind, the potential of this trade overcomes the risk of extended sideways move where we pay swap fees to stay in the position.
This is a trade where you should get short and stay short. Keep your stops wide and look to be in this trade for some time. When all the patterns add up like this, it’s actually scary that it looks so “obvious” a short. I start questioning my own thinking process because when things are too good to be true, they usually are.
But in this case, I’ve studied the evidence enough that I’ve come to the conclusion that there’s nothing to worry about. The risk of USDJPY moving significantly higher is very low. Just look at all the empirical evidence in front of you, and it’s easy to stay short in USDJPY for the foreseeable future.
Let’s look at the NASDAQ now, which is the stock index proxy for the U.S. tech sector.
The NASDAQ has made a huge 70% retracement from its initial sell-off in February and March, but last week there was some interesting price action: the NASDAQ made a bearish key reversal where the price raced to a new high but then closed at the low for the week.
Note that there was an earlier bearish key reversal just before the initial plunge. That makes this latest reversal quite interesting as it indicates the potential consequences.
That first reversal formed at the apex of a long-term descending broadening formation, so-called because it starts life very narrow at the base and grows wider near the top.
Typically when we see these formations, they’re reversals. That suggests that if and when the NASDAQ returns to the lower boundary of the formation, it will break through and drop even farther.
It’s a bit early to make that super-bearish call right now. But the latest key reversal indicates we’re on the way to testing that particular hypothesis sooner or later.
So how do we tackle this strategically? Because of the way this index has risen, I don’t think we’re about to drop straight down immediately. Yes, it happened the first time. But I’m skeptical we’ll see a direct repeat of the first drop.
Instead, I feel we’ll see a build-out where the price hovers around the current level for a while before the next descent begins. I see some kind of elastic band approach where the NASDAQ might move a bit lower and then higher before rolling over. That suggests going short on that move higher is the best move.
Then the problem becomes trying to anticipate just how high is high enough when placing a limit order.
Typically I like to put sell stops under the low and catch the momentum, but because the NASDAQ’s move higher has been so broad I don’t think it’s yet the right timing for such an order.
If you’re an aggressive trader you could try both approaches: a sell stop under the lows and a limit order somewhere within the last week’s range.
For now, I’m just going to wait. My main conclusion is that I think the NASDAQ has topped for now and that lower prices will be on the way. I just want to see how much range-bound activity occurs before I pull the trigger on the ensuing move lower.
It’s time to look at GBPNZD again (the British pound versus New Zealand dollar).
This market has been very undecided lately as it’s been moving up and down 1,000 pips with no real direction.
Now when a market gets to this level of uncertainty, I back up and look at what I call the governing price patterns to determine how this uncertainty is going to resolve.
A governing price pattern is a price pattern that governs future price action, just like the double top/head & shoulders combination we saw in USDJPY.
Here in GBPNZD, the governing pattern since late 2016 and early 2017 has been a double bottom. The market has kept moving higher in fits and starts ever since that pattern was established.
That subsequent price action includes a more recent double bottom, one where the price is now hovering at the neckline of that pattern. All GBPNZD has done for the last several weeks is churn along that neckline.
This is actually a healthy price action for the future. The more GBPNZD trades at this neckline, the more energy it will unleash when it unwinds. The eventual move is likely to be very explosive.
But because we’re going into the summer season, which typically features lower volatility in FX pairs, I wouldn't rule out that GBPNZD could go sideways for a considerable period of time first. The same patience is required before we finally see that energy release.
There’s a reason I’m bringing GBPNZD to your attention now, though.
Last week this pair drove a stake in the ground with a bullish key reversal. That’s where the market made a low and then closed at or near the high. This selloff and subsequent strength by the bulls suggests an opportunity to get back into the main direction of this trade.
This is a ‘buy the dips’ situation and you should consider getting involved here at the 2.06 level and perhaps taking some money off the table at 2.10 before looking to position yourself again. This trade may take a while to pay off, but it’s worth waiting for those dips to poke a toe or two into the water.
Now let’s take a look at XAUUSD (spot gold) and its latest price action.
Since thrusting to a new multi-year high three weeks ago, gold has not been able to make any subsequent new highs. Now this in and of itself doesn’t mean anything. Gold could be forming a congestion zone before soaring higher. I'm simply observing that since the new high, the yellow metal has effectively stalled.
That means it hasn’t been able to escape the confines of the current reverse triangle. Again, the triangle doesn’t suggest anything in and of itself. It could be a continuation pattern or ultimately a reversal pattern.
But this ambiguity is why I’ve been on the sidelines for the last couple of weeks. I’m waiting until the price action is more clear.
Plus the huge volatility we've seen recently has held me back. That volatility is evident in the price bars where we’ve seen a hundred dollar moves at a time.
I prefer to get into trades when the market is still exhibiting low or moderate volatility, then ride the momentum as the move builds. Right now I don’t see a good entry on the long side for gold.
Even the short side is a bit of gamble at the moment.
If the market rolls over from here, that would mean the recent high is a bull trap. Once the bulls realize they’re trapped, this could generate a bit of panic to the downside as they look to escape If you’re looking to capitalize on such an opportunity, a sell stop under the previous week’s lows would be the best way to play that move. That way you only get filled if the momentum is in your favor.
If that doesn’t happen, then I’m happy to wait for gold to settle down in the meantime. I’ll be happier trying the long side once the volatility has dropped off. With summer approaching, that might be exactly what happens.
And that’s it for this week!
I’m anticipating a lower USD later this year with a short position in USDJPY being by far the best way to play that move. I also like the idea of buying the dips in GBPNZD. The U.S. stock market looks like it has topped but it’s a bit premature to short it yet. Gold is vulnerable to a panic drop but I’m not personally placing a trade for that scenario.
So with that said, as always I hope you’re staying healthy wherever you happen to be around the world. We're all united by this common health crisis and hopefully, we're starting to come out the other end of it.
My thoughts and wishes are for your continued safety. I also wish you a very healthy and prosperous trading week.
Mark "DollarYenSlamDunk" Shawzin