By Sam Evans, Online Trading Academy XLT-Forex Trading Instructor
I have have had a lot of fun writing these articles and would like to thank all of you who read my regular musings of Trading Life. Personally I enjoy sharing my experiences of trading as there have been quite a few, and if sharing them with my readers helps to save the odd trading account here and there, then I am a happy man. I get plenty of questions emailed to me and I endeavor to answer as many as I can, even sometimes publicly through another one of these articles. However, on numerous occasions I have been asked to give my longer term outlook on the market and I thought that as we are coming to the end of the year, now would be a good time to do so. As this is a Forex article, I thought I would take a look at the good old US Dollar, a central and intrinsic piece of the economic puzzle. In times of yesteryear, it was the King of the Castle; in recent months, it has been demoted to jester of the court, but will this be the case for the longer term? Is the Greenback just resting itself for the resurrection of a lifetime, or does its fate lay firmly in the depths of the bargain basements? Everyone in the press and on TV is talking about the weakness of the Dollar, so I thought hey, it's time to give my opinion, too. Where is the Dollar headed next?
Well, to keep my answer simple I will just look to my charts and do my investigation to look for what price is suggesting to me. I am sure you have gradually gotten to know a little bit about my style of trading through these articles and realized that I base my trading decisions purely on Technical Analysis as opposed to Fundamental Analysis. Just ask my students in the ongoing Extended Learning Track (XLT) classes about my feelings towards news and economic information and my reply is always the same: "News is called news because it has already happened" and this is one of the single biggest reasons why I focus on price and price alone. To be honest, I approach the market each and every day with an objective unbiased outlook. I take each trading day as it comes because what happened yesterday is done and tomorrow is another day with new challenges and new possibilities. I am neither a Bull nor a Bear – I am a Market Driven Trader, nothing more, nothing less. However, in respect of the wider audience, I will attempt to give both my Technical and Fundamental opinions on the future of the Dollar in the coming months by looking at both the broad market and the Dollar itself.
The Technicals and Broad Market
I have clearly stated on numerous occasions that my own trading style is a simple one which revolves around understanding the nature of price above everything else. This involves Buying in areas of Demand for a cheap price, and Selling in areas of Supply for an expensive price. I also gauge weakness and strength in the market by understanding that price will always, at some point, revert to its average. If it is over-extended, then it is likely to revert that much quicker. With that said, let's take a look at our subject asset, the US Dollar itself, via a chart of the overall strength of the currency against a basket of other world currencies. Below is a Weekly chart of the Dollar Index; clearly we can see that for a number of weeks there has been a steady decline in the currency's value, but as we all know, nothing moves in a straight line. If the Dollar is to continue its fall, then it has to get through not one but two key areas of support first and I know, as a business man and trader, that when price approaches an objective area of demand, there is a high probability that it will take a turn. If we also note the downward move of the USD on this chart, we can also see that there have been no considerable corrections for profit-taking – remember markets never move in straight lines.
 Figure 1 And what about Gold? Traditionally, the Dollar and Gold have enjoyed an inverse correlation with rising prices in the yellow metal causing selling pressure on the Buck. As we all know, Gold has been consistently making new Highs over the last few weeks and investors can't get enough:
 Figure 2 This Daily chart shows the relentless run of Gold's upward trend and a steep one it is indeed. Much like the chart before, we have yet to see considerable correction on Gold. Ask yourself a question: Would you just keep buying something with no plan to ever sell it for a profit? Well, probably if you didn't have a plan in the first place, then the answer would be yes; however, knowing that the smart money out there is what really moves the market, ask yourself the same question and the answer is likely to be the opposite. Can you really say there is any point in buying something for speculative purposes if you never plan to sell it? Plus, on another note, what currency do you think helped pay for all that Gold...that's right the USD and we know what likely happens when Gold falls – the Dollar rallies.
Now let us shift our attention to US Treasuries and the 10 Year Notes. Bonds have always been another safe-haven for investors, as any money put into government bonds is guaranteed. Sure the interest isn't great, but the cash is safe and in times of uncertainty, the smart ones will always take flight to quality. Take a look at this chart of US 10 Year Notes:
 Figure 3 Interestingly enough, there has been a steady technical upward trend in the Notes market, with healthy corrections along the way and a general acceptance of rising prices, all the signs of a stable trend. Note that this has all been taking place while the USD has been sold off against other currencies, suggesting that while the USD is being shorted like crazy in the Forex market, it is still an attractive haven in the bond arena and who do you think invests in the bond market, the retail traders or the big players?
Finally, let's take a technical glance at the Broad Equity Market: The S&P 500. Of all the stock indexes world-wide, this is still the king of the hill and the single biggest gauge of stability and health across the board. In the chart below of the S&P 500 Futures contract, we can see the impressive rally from the March lows to the present day:
 Figure 4 To many this rally came from nowhere, well before the experts were speaking of "Green Shoots" of recovery. Those who missed the boat have happily piled in, buying as much stock as they can, not wanting to miss out on the new Bull Market. So far we have seen pretty much a "V Shaped" recovery process which from an objective technical perspective is rarely sustainable. Also of note, is that this rally has been comprised of much lower volume than previous rallies. If we understand, therefore, that this rally has been fueled by low volume, the slightly concerning issue we face is the question: "So where are the sellers hiding?" When we look at this chart, we can also see that this rally is also part of a larger Bearish trend and there are plenty of further areas of resistance this market has to cross before it can move higher. So what has this got to do with the USD? The answer to that question lies within the Fundamentals.
The Layman's Guide to Fundamentals
I will never claim to be the world's greatest Fundamental Analyst, but even I have my own simple, logic-based approach to Macro Economics. Continuing on from my Technical Analysis of the S&P 500, it is important to understand that the value of the equity markets does impact the value of the Dollar. Think about this: In times of prosperity, speculators are more likely to pile cash into riskier assets like stocks, hoping for a higher yield but the minute that confidence drops in the market, we get the flight to quality effect whereby positions in risky assets are closed and the cash seeks a safe haven like the US Dollar and Bonds. Now one could argue that the Equity Market is poised to continue higher based on past performance this year, but there has definitely been a slow down of momentum and, again we have to be honest with ourselves. After facing the greatest financial crisis the world has ever seen, the markets are unlikely to just return to the highs of 2007 in the blink of an eye. More stability has to enter the market and in my humble opinion, I believe that this rally is a dishonest one. World governments were forced to pump money into the system to prevent a total meltdown! This just shows that the markets have been artificially propped up, rather than being allowed to naturally recover. Take that money away again and I would like to see the results...
Also, we should not forget about the money which has been used to buy these stocks in the first place, and that my friends, would be the USD which has become the new Carry Trade currency of the world. Anyone can go and borrow the Buck at a next to nothing interest rate and then invest in much higher yielding assets like stocks and commodities for a greater leveraged return. Isn't leverage a wonderful thing? Oh, that's right, it got the world into trouble in the first place but hey, we have learned from our mistakes this time around, haven't we? I hope so, but let's just say that things do take a turn for the worst in the coming months and more news is released of further credit defaults (Dubai World, anyone?), then we would likely see a large scale closing of equity and commodity positions and a run straight back to the USD which bought them in the first place; a run which would create huge levels of demand for the Buck and as we know so well, demand only causes prices to do one thing.
So now we know that if the Equity market decides to sell off again, this will send demand back to the safe haven of the USD, but what is the one thing aside from credit defaults which could fuel this potential sell off? Well, in my humble opinion, it is the one most overlooked aspect of the recovery which I hear very few people talk about and that is unemployment. The rise of unemployment as a result of the credit crisis is ever present and if these figures continue to rise, then how can the market expect to continue its rally? People who are working have surplus cash to spend and consume. Industry produces in order to profit from selling to the consumer. Therefore, if more people are out of work, they are unlikely to be spending and consuming, stunting the expansion of industry across the board. A potential vicious circle and surely a possible thorn in the side of the green shoots brigade, but that's a conversation for another time.
There you have it - my personal take on the future of the US Dollar. Yes, I am Bullish on the Buck for 2010 but I could be wrong indeed; but most importantly, I already know that if I am wrong, I will lose only a little and move on to the next opportunity. Being right isn't on my agenda as I found out early on in my trading career that being "right" doesn't always equate to being consistently profitable! I hope you enjoyed my outlook - one way or another, there's a 50% chance that it will prove to be the right one! In the meantime, take care and be well.
Your British Dollar Bull,
Sam Evans sevans@tradingacademy.com
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