U.S. Dollar

Posted by Scriptaty | 1:06 AM

The U.S. dollar has been on a proverbial market roller coaster ride the past couple of years. Dollar negativism reached almost apocalyptic proportions in late 2004 — just as the buck took off on a nearly year-long rally.

Of course, in November 2005, the bears had long gone into an embarrassed hibernation and bulls were certain there was nothing to fear. The latter were soon seeing red, as the dollar turned what the bulls initially hoped was a pullback into a full-fledged rout.

Which brings us to May-June 2006, the dollar back to its spring-2005 levels, and negativism again seeming to crest (but not, it should be noted, anywhere near its late-2004 levels).

It’s daily chart of the dollar index (DXY) shows the buck rallying off a May low around 83.60, declining, and then bouncing off a slightly higher low in June. A close-up of the weekly chart shows the dollar index formed an outside bar the week ending June 9: It made a lower low than the previous week and then reversed to exceed the previous week’s high. Also, it closed above the previous week’s high and its high was higher than the previous four highs.

Comparable outside bar patterns had formed only 17 other times since 1979, the most recent instances occurring in October and November 2001. After such weeks, however, the dollar index has posted a relatively bullish performance, which is all the more notable because the dollar has essentially been dominated by depreciation for the majority of the past 20 years (1995-2001 being the major exception;.

It shows the week-to week performance of the dollar index after these outside bars. For example, one week after an outside week, the median close in the DXY was .0068 percent higher than the outside week’s close; 82.35 percent of the closes were higher than the outside week’s close. The median largest up move (LUM) in the first week was .0104 percent and the median largest down move (LDM) was -.0029 percent.

Overall, the standard deviations suggest a great deal of volatility (keep in mind 17 is a small number of pattern samples), especially in the first few weeks, but there were very high probabilities of gains over most of the following 12 weeks. There was a slight weakening during weeks 2, 3, and 4 (which currently equate to the weeks ending June 23, June 30, and July 7), after which the probabilities for closes higher than the close of the outside week remained above 70 percent, and the LUMs were consistently larger than the LDMs.

It compares the week-to-week median closing gains after the outside week pattern to the median gains over one- to 20-week intervals in the DXY (“benchmark”). For example, the median eight-week move in the dollar index during the analysis period was a -.0012-percent loss. The median eight-week close to-close move following the outside bar pattern was a .018-percent gain.

Overall, the pattern’s gains are not large, but they nonetheless stand in stark contrast to the bearishness typically manifested by the dollar.

The question is whether current conditions will support or undermine the upside bias implied by these statistics. There are those who believe the U.S. administration is intent on a weak dollar to counter the chronic current account imbalances (see “Playing with fire,” Currency Trader, June 2006), and the result could, indeed, be a severe drop in the dollar from current levels. If such a hypothesis turned out to be true, it would certainly trump the implications of this kind of analysis.

Of course, it is equally true the dollar could have bottomed — if only temporarily — and the outside week pattern is a manifestation of the typical price action that has formed up moves in this market.