The EUR/USD collapsed in the shortened holiday week of trading as the dollar index may finally be close to strengthening in the manner that I had originally predicted it would earlier this year. The stock market performed poorly on Friday and did not hold onto to gains made in the beginning of the week. Currently I am almost completely in cash and I have a very neutral stance though things continue to get worse in Europe which gives me a slight bearish bias.
The dollar index is finally beginning to make moves versus the Euro which I had believed to be the fundamentally correct course of action for a while though until now, that scenario had not been the case price-wise. I have previously expressed that the dollar has remained suppressed (particularly over the last 5 months) due to Chinese GSE’s but also because of institutions like Goldman Sachs who have publicly stated that they are increasing long positions in the Euro and short positions in the dollar. It is in their interest to keep the dollar suppressed in order to maintain the illusion of recovery. However, now fresh shorts are already well underwater as the dollar pierced through the 200 MA with conviction this past Friday and a short squeeze could be in play after the dollar consolidates here as the $77 area is a major resistance level.
The 200 MA is obvious resistance, but there is also a pivot low from February at $76.88 which was also pierced and if you use the weekly chart, you will notice that the weekly 50 MA coincides with the 200 MA on the daily. Furthermore, $77.10 is a 50% retrace from the January 2011 high ($81.32) and the May 2011 low ($72.70). Last but not least, $77 is major resistance because the DXY did not consolidate before piercing the level and instead gapped higher in a very short period of time, indicating an overbought condition. Keep in mind though that the dollar was oversold (and suppressed) for a long period of time so despite this short-term overbought condition, any news out of Europe can causes short to cover and the dollar to rip higher yet again.
The bear flag on the SPX has all but broken down though support still remains at the lower trendline. This pattern is not valid until the market can confirm below the support trend and at that point it may be safe to short stocks that are still elevated in price, though I am personally not at all pressured to participate given the increased risk of volatility. The target for this bear flag is 1010, or the June 2010 lows.
If copper decisively closes below $3.99 tomorrow, that would indicate a technical breakdown of the bear flag and the pattern would then be in play. In other words, this chart is indicating a very bearish outlook over the next week to two weeks but again, there are other reasons to not take this as law and short the market.
One of those reasons is because oil held up well on Friday. There is the possibility that oil did not collapse because of the traveling that took place on Labor Day weekend and that it will begin to sell off next week, but that assumption leaves too much in question to base investment decisions on.
Another reason is that the financials have surprisingly held up, relative to the lows put in during the end of August. The pattern on the chart is beginning to look like a potential inverse head and shoulders or perhaps a W-V reversal. The entire situation that we’re in now has everything to do with the financial sector so the fate of financials is tied to the fate of the overall market and additionally, financials are a leading indicator of the market’s performance.
Again, there is no reason to leverage into excessive short positions at this point based on the news. We know Europe is bad, we know financials are a disaster. Every time the media mentions this, the short side looks less and less appealing. Today I saw that Forbes posted a chart of the bear flag on the SPX that I have pictured above. This tells me that retail investors may be looking to short the market. I never want to be on that side of the trade. In any case, be sure to look for oil and financials to confirm the other charts like the SPX, DXY, and Copper before beginning to go short, or long for that matter.
I may take short or long positions next week based on short term momentum but currently I don’t have much of a bias regarding permanent direction. If you do have your mind set on shorting the market in fear of missing the move, use a fractional position to buy November-January out of the money puts that coincide with the strike prices of the June 2010 lows. The small amount of capital committed to the option would not require high risk, and the distance away from the current strike could give you a high reward, regardless of the small capital commitment.