Using S&P 500 to Spot a Dollar Bottom

05/03/2011 6:00 am EST

Focus: FOREX

J.W. Jones

Chief Options Strategist, Technical Traders, Ltd.

The charts show the potential for a US dollar bottom to coincide with the S&P 500's test of a rising trend line, and while it may not mark the exact bottom, it's an important relationship to watch now.

The dollar index weekly chart below illustrates the sharp selloff in the US dollar over the past few months-indeed, almost the entire past year:

chart
Click to Enlarge

While several past MoneyShow.com articles have been proffered by authors I respect deeply, they have not offered a means to determine when the dollar has bottomed. While nothing is foolproof, the longer-term SPX chart may be a guide as to when the US dollar will begin to bottom. The SPX weekly chart shown below illustrates the long-term ascending channel that the S&P 500 has been trading in for some time.

My "educated guess" as to when the dollar will begin to bottom will likely coincide with a test of the ascending trend line. In previous articles, I opined that I thought we would see the S&P 500 rally, and we are in that process now.

My guess is that about the time the S&P 500 tests the rising channel, we will see the US dollar begin to bottom. The short opportunities that will be presented from a risk/reward perspective could be outstanding. Cycles typically line up, particularly when one particular asset-in this case, the US dollar-is driving markets in one particular direction for a long period of time.

chart
Click to Enlarge

Typically, business cycles end when commodities and commodity-based stocks such Exxon Mobil (XOM) or Barrick Gold (ABX) rally. We are in that stage of the business cycle right now, and typically, when that stage has been reached, it is indicative that the economy is starting to overheat.

Cyclicality in financial markets has been discussed for years, but often times, technical analysis will align with the business cycle. While I may not be exactly right as to the timing, it certainly gives a solid framework for risk-based decisions for trading the US dollar going forward.

By JW Jones of OptionsTradingSignals.com

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