Greenback will test support levels in next few weeks

The US dollar is testing the support levels of a long-term consolidation pattern that began in November 2005, which if broken can result in a 25% drop in the greenback.

In November 2005, the dollar index took its first step into the consolidation pattern. The index measures the US Dollar against six major currencies.

It’s only on November 2009 that long-term consolidation pattern confirmed itself. Now a break out of the consolidation pattern can result in the dollar index moving 25%.

As the index is testing the support levels of the consolidation pattern a break in the next few weeks could result in the dollar dropping 25% over the next several years.

However, if the dollar rallies from the current support levels and breaks out of a resistance level, we could see the dollar rally 25% after the break.

Till such time the consolidation pattern is not broken it will move up and down within the range. I had mentioned the long-term consolidation pattern in earlier articles, but bring it up again as there is possibility of a break down from the range.

The pattern we are talking about is the symmetrical triangle. In this pattern prices move in 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. The chart shows the symmetrical triangle on the dollar index.

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 symmetrical triangle.

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

Finally, how far the price 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 25%. Note that in case of the dollar index now a breakdown can result in a full measured move only after the previous lows are broken through.  The previous lows are 77.25, 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 powerful chart pattern and prices tend to move in the direction of the break a long way.

Gold is a great example of a break out of a symmetrical triangle.  Between January 2009 and August 2009, gold moved in symmetrical triangle pattern and broke above the pattern at $984 per ounce.

Once the pattern was broken gold continued to rally all the way up to $1425.

Finally, prices generally tend to break in the direction in which it entered the triangle. In the case of gold prices were rising before forming a symmetrical triangle, it then broke out and rallied to all time highs.

Dollar on the other hand was falling before forming a symmetrical triangle, which is bearish for the greenback.

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