How the US Dollar Can Help You Spot a Market Bottom

12/17/2010 12:01 am EST

Focus: FOREX

Looks like fear is creeping into the equities market. This Wednesday, we started to see fear (green indicator) reach a level that tells me to start looking for the market to bottom out. I do follow a few other charts and indicators that warn of a possible trend reversal (high-probability set-up) before it takes place, but the US dollar and selling volume are key.

As we all know, when the market is trying to top and roll over, it tends to be more of a process than a couple-day event. It’s this lengthy topping process which has a lot of choppy price action and sucks traders into a position much too early or shakes you out of the position before the market does what you anticipated.

On the flip side, bottoming is more of an event because it tends to happen after a strong wave of panic selling. Fear is the most powerful force in the market (other than the Fed/manipulators, but that’s another topic). That being said, when you know what to look for in bottoms, you can generally see the market starting to bottom and prepare for it.

The charts below of the US dollar index and SPY clearly show the inverse relationship they have. Right now it seems everything is directly connected with the dollar—it has been like that for most if the year. I will note that it’s not normally this clear. Anyways, the dollar is currently trading at resistance, which means there is a good chance it will turn back down. So if the dollar drops, then it should boost SPY (the equities market) and put in a bottom for stocks.

Click to Enlarge

Looking at the lower chart of SPY, you can see that recent prices have dropped down to a support zone. The important thing to note here is how selling volume is ramping up. This to me means more traders are getting worried and are cutting their losses or locking in gains before it gets worse. We typically see panic selling enter the market near the end of pullbacks. Just like in a bull market where the retail trader (John Doe) is the last to buy before the market falls, it’s the same except flipped in a downtrend. The retail trader is the last to panic and sell out of their position before the market bounces/rallies.

Currently, the equities market looks to be showing signs that a bottom is nearing. Over the next session or two, the rest of this equation should come to light as a tradable bottom or opportunity to start playing the down side of the market. Only time will tell…

By Chris Vermeulen of

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