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August 22, 2012 / redman59

Dollar Confirming the Move in Equities

On my trading platform I keep what I like to call a risk/macro grid.  It has several charts that I watch to include the US Dollar Index (/DX).  It is no secret that the /DX usually has a strong inverse correlation to the market so watching the /DX can tell the trader that if a market moving up is confirmed by the /DX moving down.  If both instruments are moving up then there is usually a tendency for one of them to break and bring the inverse correlation back in play.  So why does the /DX have and the market have an inverse correlation?  There are several reasons that could go into it and probably be a research paper in itself but I have found the best summary and easiest to understand summary at The Market Oracle:

  1. It inflates the dollar value of US stocks as they fall in value in foreign currencies.
  2. It inflates the dollar value of foreign earnings and hence boosts U.S. corporate earnings.

Below is a chart with notes and you can see that the US Dollar (as measured by $UUP) remains in its down trending channel.  I had to use the UUP in order for the correlation study at the bottom of the chart to be whole and not broken up.  But you can see that the correlation usually remains strongly negative more often than not remaining below -0.50.  Some other items worth noting:

  • Double Top chart pattern formation
  • 10/20/100ema’s are sloping down as well as the 50sma

Overall the price action in the /DX is confirming this move in equities and bodes well for a continuation of trend in the stock market.  Out of all these notes the one thing that I will be watching for a change in trend will be a break out of the current down trending channel followed by higher highs and higher lows in the /DX.  Until then the trend remains intact.  I also want to note to keep in mind your time frame.  If you are day trading or trading those quick swing trades, then watching the /DX is not as important but can be used as a gauge for reasons stated above.

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