Quite a bit has changed over the past three months in the forex market, but the next few months could be even more important in terms of determining the intermediate- to long-term trends in many of the currency pairs. Clearly, the divergences between the various pairs have become more pronounced, which requires more careful analysis and trade selection based on risk/reward. The various currency pairs have reached some important Fibonacci levels, so I wanted to look in-depth at not just the dollar index, but also many of the other popular pairs.

Figure 1 - Click to Enlarge

The monthly chart of the dollar index, using the continuous futures contract, gives us an interesting long-term perspective. The rally from the March 1995 lows to the June 2001 highs lasted 75 months, while the decline from those highs to the March 2008 lows was 80 months. Within this decline, there have been two eight- to nine-month contra-trend rallies.

The rally from the 2008 lows to the 2009 highs fell just short of the major 38.2% resistance (point 1) before the dollar turned lower. This now makes the downtrend, line a, in the 88 area, an important level of resistance. The rally over the past three months has so far fallen short of the minor 50% retracement resistance, but you will note that it has reached the long-term chart resistance, line b, that goes back to 1992.

Though often times we do see very clear divergences in the weekly or monthly indicators at major turning points, especially when using volume based indicators, this was not the case at the 2008 lows in the dollar index. The demand indicator is a volume-based indicator, and it has recently moved back above the zero line after confirming the 2008 lows, line f. Clearly, the extent of the next pullback will be important as it is critical that the support at line e does hold. For now, the rising weekly studies keep us positive on the dollar index’s intermediate-term outlook.

Figure 2 - Click to Enlarge

The short-term outlook does look much different as in early March, there were some signs that the dollar’s rally was losing upside momentum. Sentiment was also too bullish on the dollar and negative for the euro, which was consistent with the technical outlook, increasing the odds of a correction in the dollar index. The weekly studies had stayed negative from March 2009 (see chart) to early December 2009 (see related article) when the technical studies suggested at least a short-term low was in place. The initial upside targets were at 78, and then in the 80 area, which corresponded to the major 38.2% retracement resistance. The high so far has been 81.43 with the 50% retracement resistance at 82. The high was very close to the target from the Fibonacci projection using the rally from point a to b and then measuring up from the low at point c, as the equality target (100%) was at 81.00.

The daily OBV did form a short-term negative divergence at the recent highs and then dropped below its WMA and the uptrend, line 1. This is consistent with a short-term top, though with the weekly studies positive and not diverging, we are looking for a correction, not the resumption of the dollar’s long-term downtrend. There is key short-term support now at 79.60-85, basis the March contract. As long as this support holds, we can’t rule out one more push to the upside before a more significant correction. The 38.2%-50% band of Fibonacci support is in the 78.60 to 77.90 area. On a decline into this support zone, the bullish divergence support in the OBV, line 2, is likely to be tested. If it is decisively broken, it could alter the intermediate-term outlook.

NEXT: Latest Analysis on USD/AUD; What's Ahead for Euro?