Despite record dollar printing recently, the US Dollar Index's trajectory remains higher, buoyed, among other things, by America's rapid economic recovery from the recession caused by the pandemic and now its highest level of inflation in decades.
The 40-year-high spike in prices is likely to force the Fed to remain true to its fiscal policy mandate to tighten liquidity and increase rates, even at the expense of political considerations. In contrast, central banks in the eurozone, Switzerland, and Japan continue to drag their feet on rate hikes, providing USD holders with favorable interest rate differentials.
Additionally, the ongoing crisis vis-à-vis Russia and Ukraine, which also involves the US and western European allies, serves up yet another reason why global investors do well to move their holdings to dollar denominations, since the world's most stable political system supports the greenback's value.
However, trading is never as simple as taking a fundamental reading of a situation and placing bets accordingly. There are often layers of complexity and almost always surprises. To that point, right now the dollar is under technical pressure.
The USD has been trading within a potential Diamond pattern, visible on the chart above. It's a rarely seen formation, perhaps because of its complex nature.
The pattern reflects a combination of two different environments. The first half is a Broadening formation, which can also top out an asset, due to the lack of leadership in the trend, with highs rising while lows descend lower. The second half is a symmetrical triangle, whose symmetry suggests a resumption of the underlying trend.
However, given that the preceding dynamic was lopsided, the same negative sentiments follow, upon a downside breakout. Note though that the pattern is not complete until such a downside breakout occurs.
Trading Strategies
Conservative traders should wait for a downside breakout to short, with a minimum 3%, 3-day penetration to filter out a bear trap. Alternatively, they would go long, using the same filters to the topside.
Moderate traders would be content with a 2%, 2-day penetration on either side of the pattern.
Aggressive traders could enter a long position now, considering the price is on the bottom of the rising channel and near the bottom of the Diamond. Money management is critical. Here's an example:
Trade Sample – Aggressive Long Position:
- Entry: 95.75
- Stop-Loss 95.50
- Risk: 25 pips
- Target: 96.50
- Reward: 75 pips
- Risk-Reward Ratio: 1:3