After a robust 2003, the Canadian dollar pulled back vs. the U.S. dollar in the first four months of 2004 before pushing to new relative highs in September. The U.S. dollar/Canadian dollar (USD/CAD) rate on Oct. 20 broke down below the shorter-term support level (around 1.25) it had established earlier in the month.
Although there is speculation in some circles the Canadian dollar stands a good chance of continuing
to gain against the dollar — the recent price thrust and rate hikes by the Bank of Canada would seem to support that position — there are several reasons for traders to be mindful of the potential for a correction, if not a larger reversal, in the not-too-distant future.

Technical traders will watch how the 1.25 level in the USD/CAD acts as resistance after being penetrated as support. If another meaningful down move is in the wings, technicians will look for this level to turn back any upside correction, and will not want to see it exceeded significantly or for very long. A move above the Oct. 13 spike high of 1.2688 would at least temporarily invalidate the downtrend scenario, but most chart watchers will be nervous about a strong or sustained move up to 1.2575-1.2600. Testing a pattern modeled after the four-day sell-off that occurred from Oct. 20 to Oct. 25 showed a slightly bullish short-term tendency after such moves.
It shows the percentage returns (measured from closing prices) for the first 15 days after a four-day down move greater than 2.5 percent when the three most recent closes were lower than the preceding closes.

There were 14 previous patterns that met these criteria since 1998, the most recent being March 29 and 30, 2004. Except for days 8-10, the average moves were marginally higher (day 3 had a negative median return), and all days but two (days 2 and 3) had positive returns at least half the time. Also, although days 8-10 had negative average returns, their median returns were positive — which
implies an “outlier,” or exceptionally large, non-representative value has distorted the average — and the percentage of positive returns on that day were 71 percent. (However, the mild upside bias turned slightly negative in days 18-20 after the pattern, not shown).

A 120-minute chart of price action through 11:30 a.m. ET on Oct. 27, shows the USD/CAD
having established a third progressively lower short-term support level, but was trading slightly higher
on the day. In addition, Commodity Futures Trading Commission Commitment of Traders data shows small speculator long positions at one of the highest levels of the past 12 years, which is typically viewed as a contrarian signal because of the pattern for small traders to be on the wrong side of the market near turning points (see “Canada looking toppy”).

The U.S presidential election on Nov. 2 might also have a role to play. “Elections and the U.S. dollar“ shows a long-standing tendency for U.S. dollar to rally after elections.

And of course, there is little in the markets that crude oil cannot impact these days. Crude’s historic strength this year has bolstered Canada’s (an oil exporter) economic bottom line this year, and any significant sell-off will affect the CAD.

In short, traders who have most recently jumped (or re-jumped) on the Canadian dollar bull bandwagon could be in for a rough ride if any combination of these factors align in the coming weeks.