Dollar index breaks a six-year pattern

As the world focuses attention on the Middle East turmoil, the dollar had a silent revolution. The dollar index finally broke its six-year consolidation pattern to the downside, signaling the continuation of its long-term bearish trend.

Technical analysis of the dollar index projects a 17 point or 22% drop over the coming years. The index closed outside its consolidation pattern on the monthly chart at the end of February and continued to move down this month.

The index closed at 76.40 last Friday and is projected to fall to 59.77 in future.

Put simply, a break in a consolidation pattern is like a crack in a dam where the water pressure has been rising. The water starts to flow out slowly at first and when the volume increases, the gushing liquid widens the crack. Essentially, buyers of the dollar begin to panic and sell off.

The dollar index broke out to the downside from a consolidation pattern called the symmetrical triangle as shown in the dollar chart.

These are powerful continuation patterns and as the dollar index was falling before forming the pattern, it is expected to continue going down. Gold too was in a consolidation pattern a few months back and broke out of it to rally to all time highs.

Since a major chunk of global trade is priced in US dollars, the falling greenback can distort balance sheets of companies and countries, fuel inflation and drive up commodity prices.

The loose monetary policy of the US Federal Reserve for the past several years is expected to spread the cancer of inflation into the distant future. 

The dollar index took its first step into the consolidation pattern in November 2005. In a symmetrical triangle pattern prices move in a continuously narrowing range.

The symmetrical triangle is drawn by connecting lower highs with a downward sloping line and the higher lows with an upward sloping line.

A lower high is when the latest high in price is lower than the previous high and a higher low is when latest low in price is higher than the previous low.

A symmetrical triangle or any other consolidation chart pattern shows indecision in the market. Till the market resolves where the dollar must go, it will continue to move inside the borders of the triangle.

A price move out of the triangle is the first indication that the market is taking direction. The second indication is when prices break the previous highs or lows outside the triangle. 

Finally, how far the prices move is forecast by the measured move. A measured move is arrived by measuring the distance between the second touch of the triangle and the sloping line above or below it.

In the case of the dollar index it works out to nearly 22%. Note that in case of the dollar index now, a break down can result in a full measured move only after the previous lows are broken through.

The previous low areas on the dollar index are 75.60, 74.80 and 71.60.

Conservative traders take some profits when 75% of the measured move is made. However, a long-term symmetrical triangle is a powerful chart pattern and prices tend to move in the direction of the break a long way.

The writer is editor, www.capturetrends.com and based in Chicago