Assessing The Trend In The U.S. Dollar

By Joey Fundora | December 15, 2009 AAA

One of the most talked about financial stories this year was the continued decline in the U.S. dollar. With the government reducing interest rates to nearly zero in an effort to combat a possible depression, the dollar has endured one of the longest declines in its history. This has helped push gold to all-time highs, and has forced investors to search for asset classes with a higher rate of return. Recently the dollar has started to turn higher, and many are speculating a possible end to the decline. It also seems that participants for both sides in this asset class are also staunch in their belief of the ultimate outcome; on the one hand, dollar bears believe the current policy will spark hyperinflation, as the Fed has made it clear it will keep the presses running. Dollar bulls, on the other hand, believe the real threat is deflation, and that the economy remains very vulnerable.

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One of the benefits of using technical analysis, is that there is no need to be emotionally tied to a trade. The charts simply display what is occurring in an objective manner. One way to objectively look at a trend is to overlay the chart with multiple moving averages. This method overlays a chart with two clusters of moving averages, one a slow group, and the other a fast group. By paying attention to the moving average clusters, a trader can easily assess the current trend and remain objective about a trading opportunity.

While some traders are starting to get bullish on the U.S. dollar, a multiple moving averages chart of the PowerShares DB US Dollar Index Bullish ETF (NYSE:UUP) is showing that the U.S. dollar remains in a steep decline. All of the fast moving averages (shown in green) remain under the slower moving averages. While UUP itself has finally climbed over the cluster of moving averages, it will take much more work to bullishly align the moving averages. It is very possible that the dollar is setting an important low, but realistically, it takes several weeks, or even months, for a stock to transition from a steep decline to an uptrend. Often, the downtrend is broken and turns into a consolidation. Bulls would be wise to use caution until UUP can begin to drag the moving average clusters into an uptrend.

Source: StockCharts.com

The chart for the SPDR GOLD SHARES ETF (NYSE:GLD) is almost an exact opposite of UUP, and for good reason. Gold and the U.S. dollar have an inverse relationship and will usually track in opposite directions. The chart for GLD shows a very strong trend, with the moving average clusters layered neatly and rising. Often pullbacks to these clusters will be met with support, as traders begin to find prices attractive compared to recent history. While the short-term chart for gold got ahead of itself and is showing signs of exhaustion, the longer term chart will remain bullish until a large reversal pattern emerges. (For related reading, check out Why Gold Matters.)

Source: StockCharts.com

United States Natural Gas Fund ETF (NYSE:UNG) is a good example of how a pervasive trend will tend to persist over time. UNG has been in a steady decline, which is quite evident when you look at the chart displaying the multiple moving averages. Notice how UNG has experienced multiple false breakouts, even after it was able to clear the moving average clusters. Funny enough, UNG is in the process of testing the moving average cluster again, while RSI is showing a positive divergence. However, until UNG can begin to pull the moving averages into an uptrend, it will be difficult to trust any rally.

Source: StockCharts.com

United States Oil Fund ETF (NYSE:USO) is a good example of how even after turning the moving averages higher, often a consolidation is needed before a true rally can emerge. Notice how USO cleared the downtrend in March and was able to pull the faster moving averages above the slower ones. It then traded sideways long enough to pull the slower moving averages into a sideways trend, before exploding higher in the summer. USO is currently weak, and is breaking under the moving average cluster.

Source: StockCharts.com

Bottom Line
Often traders can get emotionally attached to a particular thesis, and a simple analysis technique like plotting multiple moving averages can help keep them honest in assessing the underlying trend. Trading is often more successful when aligned with the longer term trend and the dollar is still in a longer term downtrend. While there are no guarantees that this trend will persist, even if the dollar really is bottoming, a lengthy consolidation is likely. Once a trend is in place, there will often be plenty of opportunities to get on board. (For more, check out our Moving Averages Tutorial.)

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At the time of writing Joey Fundora did not own shares in any of the companies mentioned in this article.

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