Analyzing the Forex Markets—October 2009

Over the past few months, the focus has increasingly been on the action in the dollar as its weakness has corresponded to strength in stocks and commodities. As several analysts have pointed out, the bearish sentiment has reached extremes over the past few weeks, and recently, only about 5% of the analysts were bullish. The dollar has also been the focus of the financial press, which generally makes me nervous. Forex traders know that the technical view of the dollar index is often much different than that of the other currency pairs, and so an in-depth look at all of these markets seems timely.

Figure 1 - Click to Enlarge

The dollar index completed a top the week of March 13, point 1, as the RSI  gave a clear reversal signal. The OBV dropped below its WMA the next month (point 2) and then violated more important support, line d, in mid-May (point 3). The OBV is currently well below its declining WMA. Despite a couple of two- to three-week rallies, the decline has been quite steady with no sharp weekly drops. The dollar is now approaching the next band of support in the 71.50-74 area. The next Fibonacci projections are at 66.50, which is the 127.2% downside projection of the 2008-2009 rally. This also corresponds to the long-term support on the weekly chart, line c. Given the high degree of bearish sentiment and the fact that the gap between the OBV and its WMA is so wide, a rebound is likely before year end. I would expect any rallies to be similar to what occurred in early and late 2007, which I have noted on the charts by circles a and b.

Figure 2 - Click to Enlarge

The Australian dollar is one of the few currencies that is approaching its 2008 highs as it has skyrocketed from the March lows in the .6200-.6300 area (point a) to over .9200. The OBV on the aussie dollar futures moved above its WMA and downtrend, line e, at the end of March. The move above the late-2008 highs confirmed that a bottom was complete, as noted on this May 7 chart. The OBV was already back to its 2008 levels as we approached the major 61.8% resistance in June (point b). After a shallow, five-week correction, the uptrend resumed with the OBV staging a major upside breakout, point 1. If the current rally from the low at point c equals the rally from point a to b, then it would take the aussie back to the .9650-97 area and the upper boundaries of the trading channel. The 2008 high in the cash was .9849.

NEXT: Review Continues with British Pound and USD/CAD

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The rebound in the British pound can be called anemic at best considering it has just slightly exceeded the 38.2% resistance level. This is not surprising considering the state of their economy and very aggressive lowering of rates. From a technical picture, it is likely to be one of the weaker economies going forward. The pound did rebound last week, but most of the weekly technical studies are quite negative. The OBV is acting weaker than prices as it dropped back below its WMA in April and has recently violated key support, line b. This suggests that eventually the early-2008 price lows will also be broken.

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The daily chart of the British pound shows that the correction over the past two months was rather shallow as it held just above the 38.2% retracement support. The daily downtrend, line a, is now being tested and a strong move above the recent highs at 1.6740 will confirm that the correction is over. On a move above the August highs at 1.7040, the next major target is at 1.7360, which is the major 50% retracement resistance while the 127.2% projection of the recent correction is just below 1.7500. If the pound does move above the August highs, multiple negative divergences should be formed, which could create a very good selling opportunity.

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The dollar peaked versus the Canadian dollar on March 9 at 1.3062. The rally fell well short of the major 61.8% resistance at 1.3500. The RSI formed a strong negative divergence at the highs, line c, as the RSI just barely moved back above its declining WMA as the dollar was making new highs. The plunge to the 1.1000 area was relentless, setting the stage for a sharp six-week rally that eventually failed. The next major band of support is in the .9700-1.000 area. This also corresponds to the former downtrend, line b, which was overcome in 2008. The weekly technical studies are still clearly negative and show no signs of bottoming.

MORE: Study Concludes with Review of EUR/USD and JPY/USD

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The rally in the euro from the March lows at 1.2525 has been a bit uncommon since it was not that impulsive. The major 61.8% resistance at 1.4620 was overcome in September with the 78.6% resistance at 1.5250. The RSI did not form any weekly divergences at the lows, but since March has been clearly above its rising WMA, which is a positive sign. The major bearish divergence resistance in the RSI, line 3, was not overcome until September, but the uptrend is clearly intact

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I have always recommended that FX trader follow both the cash and futures markets when possible. The recent volume in euro futures provides a good example of why this can be advantageous for cash traders. The OBV moved through key resistance, line c, on August 25, leading the breakout in prices by 12 trading days. The OBV pulled back to its WMA as the euro tested its uptrend, which created a good entry point. The OBV has continued to confirm the new price highs, which is positive and suggests that a top is not yet complete. Using the correction from a to b, the 161.8% target at 1.4245 was hit perfectly in early June. The 261.8% target is at 1.5200, which coincides nicely with the weekly resistance at 1.5250 and makes this zone the level to watch.

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The dollar peaked versus the yen at 124.30 in June of 2007, and has since been in a well defined downtrend, line a. The weekly chart shows a potential double bottom, line b, but a move above the April 2009 highs at 101.40 would be very positive. The RSI is acting stronger than prices, line d, which is evident by comparing its slope with prices, line b. The RSI is still below its WMA and a move above it would be positive. The long-term downtrend in the RSI, line b, needs to be broken to confirm the bottom formation.

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The daily chart of the JPY/USD (through October 19) shows the dollar's eight-day rally from the lows at 88.00, which was a downside projection. This projection was derived by taking the distance from a to b and then projecting down from point c with the 100% level at 88.00. No positive divergences yet on the daily RSI as it made lower lows, line 2. The longer-term resistance, line a, is well above current levels, therefore, the recent dollar strength looks like a rebound in the downtrend with initial resistance at 91.50 and stronger at 92.50. A drop below 88 over the next few weeks should cause the formation of positive divergences and possibly create a low-risk buying opportunity.

Cleary, this analysis suggests that the currency markets need to be watched closely going into the end of the year because there may be some important developments. I am considering doing more regular in-depth analysis of the forex markets and would appreciate your input at tomaspray@moneyshow.com.