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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.

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):

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).

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):

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.

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