Dollar index bounces from support, but must clear gap down to rally

The dollar rallied from a strong technical support level last week and is now showing signs of potential bullishness. A break of the most recent high of the dollar will confirm the bullish trend.
On a fundamental level, the sell-off in the US equity markets increased risk aversion, leading to demand for the dollar, which is seen as a safe haven.

The bounce in the dollar is just a correction to the multi-year downtrend and may not last long. We believe the greenback will resume its downtrend after a correction, but till such time, one must switch from a bearish to a bullish bias.

The dollar had a very wide support range between 73.92 and 72.27. On June 7, the dollar hit 73.88 and rallied. The definition of a bullish trend is when prices make higher lows and higher highs. A higher low is made when the latest low in price is higher than the previous low and a higher high is when the latest high in price is higher than the previous high.

On June 7, the dollar made a higher high and rallied. The dollar touched 73.88, which was the latest low with the previous low being 72.27. This is first indication that the dollar may be turning bullish. But the trend will be confirmed only after the greenback breaks above the most recent high of 76.95 made on May 23. The dollar closed at 75.18 last Friday.

The greenback does face a few hurdles before it can make a new high. The first area to clear is 75.50, which is a gap down. A gap down happens when prices close at a certain level on Friday and then open lower next week. A gap down is an extreme area of resistance, which can turn prices down when the dollar returns to it. After the gap down area is broken, the dollar faces resistance from 76.24 to 76.97 level. Both the areas need to be cleared for the dollar to confirm a bullish trend.

Euro-dollar
The EUR-USD pair sold off last week as the dollar rallied. However, the euro turned before it reached an area of resistance in response to the dollar bounce from support. The price action of both asset classes don’t inversely mirror each other as the dollar futures contract tracks the dollar index which measure the greenback against a basket of currencies. The EUR-USD pair, on the other hand, only measures the euro against the dollar.

The EUR-USD pair closed near a support zone of 1.4279 - 1.4330 on Friday. Given the dollar’s bullishness, we may see this level broken, which can take the pair to its next level of support between 1.3968 and 1.4128. It’s always a good idea to also look at the S&P 500 and the euro as the equity markets are positively co-related. The S&P 500, which is in sell-off mode, has support between 1236 and 1247. The futures contract on the index closed at 1263 last Friday.

US dollar-Japanese yen
USD-JPY has been breaking its support and resistance levels, quite often making it a difficult pair to trade. The support level on the pair right now is at 79.55 and prices closed at 80.23 last Friday. In case the 79.55 level is broken, the pair moves into the wide range where it traded during the Japanese earthquake. The range during the day of the earthquake was 76.36 to 79.74.

It is highly unlikely the pair will fall rapidly once it enters the zone. In fact, the price action was so fast on the day of the earthquake that there is no clear support level once prices fall below 79.55. Ideally, one should stay away from this pair if it falls below 79.55, till some support and resistance levels are formed with future price action.

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