Dollar Index Short Setup

After an extensive run thus far in 2014, I believe that the risk/reward in the Dollar Index, at least from a tactical perspective, favors the short side.

The first thing I want to look at is sentiment as unwinds in extreme optimism or pessimism can be a very strong catalyst in driving any market.

The chart below an index calculated by Sentimentrader.com from a number of sources including futures and options data, surveys, and a few others. What we can see here is that there is extreme optimism in the Dollar Index right now. In fact, what’s not shown on this graph is that the reading from early October of 88 is the highest we’ve ever seen. Couple that with every media outlet running specials on how to play the strong Dollar and I’ll take the other side of that trade anyday. (P.S. The “Smart Money” commercial hedgers agree as data from Sentimentrader shows that they are hedging more aggressively than at any other time in history.)

Dollar Sentiment

Well since sentiment is telling us to lean neutral/bearish, let’s see what price is telling us.

The signals we are getting from the 10 year weekly chart are mixed and suggest a neutral stance is best here structurally.

1. Breakout above nine year downtrend line.

2. Price testing a six year resistance level in the mid 88s.

3. Negative momentum divergence at new highs.

4. Rising 200 week simple moving average.

5. No clear pivot to trade against on the short side from a structural perspective.

Given the signals above, we’ve determined that we can’t be short from a structural perspective as long as we remain above the trendline and October lows. Bulls want to see some consolidation up here for sure.

Dollar Weekly

Despite the neutral/bullish stance represented on the higher timeframe, if we take a look at the daily chart we can see that the risk/reward is favoring the short side here for a few reasons.

1. Price has run into the 161.8% fibonacci extension of the October pullback.

2. A significant negative divergence in momentum has developed as price made new highs.

3. We’re running into longer term resistance outlined on the weekly and a short term profit target at the 161.8% extension.

4. Rising 200 day simple moving average.

Dollar Daily

Given these signals on the daily, the conclusion we reach is that we would want to be aggressively short below 86.80, which is the gray box and early October highs that we broke out above on the 10/31. We want to wait for this level to break because it would confirm the negative divergence we’re seeing in momentum and provide us with a level to define our risk at. Our first target would be a move back toward the October lows near 84.50-84.75. If we close back above those early October highs, we know we’ll be wrong and move on.

That’s what I’m seeing in the Dollar Index. Feel free to share your thoughts with me on twitter or stocktwits @brunicharting.

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