It’s one of the world’s most important assets…
It just went from one extreme to the other…
And because of its role in the global economy, its next move could tell us a lot about what’s to come in the markets.
U.S. stocks, foreign stocks, commodities… They’re all affected by the U.S. dollar.
So today, we’ll look at the recent action in the dollar. We’ll show you where it’s likely to go from here. And we’ll tell you what it means for the markets.
A currency acts a lot like the share price of a country.
And relative to other currencies, the U.S. dollar has a history of stability.
For that reason, countries around the world hold it in their reserves… and use it to conduct international trade.
This makes the U.S. dollar the world’s “reserve currency.”
International assets like energy and precious metals are often priced in dollars.
So when other countries or businesses want to buy these assets – or goods that are made in the U.S. – they first need to buy dollars.
When the dollar is weak, folks with other currencies can buy more dollars… and more U.S.-made goods. When the dollar is strong, they can buy less.
This contributes to strength and weakness, respectively, in U.S. businesses.
Also, when the dollar falls, it takes more dollars to buy a barrel of oil or an ounce of gold, for example. So a falling dollar usually corresponds with rising asset prices. And a rising dollar usually corresponds with falling asset prices.
For most of 2015 and 2016, the dollar traded in a big, sideways range. Then last year, after briefly breaking out of its range to the upside, the dollar plunged through the lower bound of that same range.
As you can see in the chart below, the dollar has rallied over the past few weeks. And it’s getting close to “testing” the lower part of its former range. Traders call this level “resistance,” because asset prices often reverse when they rise up to important points like this…
After such a sharp drop last year, it’s not surprising to see the dollar stage a strong rally. But this price level is an obstacle that could end the rally.
And it’s not the only one…
As we noted above, the dollar has gone from one extreme to the other. You can see these extremes in the relative strength index, or “RSI.”
The RSI measures overbought and oversold conditions. When an asset drops hard and becomes oversold (with an RSI below 30), it can be a good idea to bet on a short-term rally. When an asset rises quickly and becomes overbought (with an RSI above 70), it’s a good idea to be cautious. It may be due for at least a short-term drop.
As you can see in the chart below, the dollar dropped at the start of the year and its RSI fell as low as 19.5. It was oversold. Now, with the dollar’s rally, it has an RSI of 74. It’s overbought…
What happens next is important…
A lot of investors and traders are now calling for a stronger dollar. But if it can’t break above these levels, it could fall all the way down to its early 2014 levels (around 80). That’s a huge drop that few are expecting.
If the dollar’s decline continues, we’ll likely see a strong move higher in commodities. It would also support big U.S. businesses that sell goods internationally and their stocks.
It would open up a lot of great trading opportunities in these areas.
If the dollar breaks through its resistance, it would be a major sign of strength… And it could rally back up to the top of its previous range (around 100).
That would be a major headwind for commodities. And it could add to the worries about U.S. stocks.
For foreign stocks, though, a strong dollar is a supporting tailwind. It makes foreign goods cheaper for U.S. buyers… So foreign businesses benefit from increased exports.
In a “stronger dollar” scenario, we’ll look for more trading opportunities abroad.
For now, though, we just want to wait and watch. We expect the dollar will have trouble pushing higher here… But the U.S. economy has been strong. So the “share price” of the U.S. – the dollar – may keep moving higher.
Either way, as we’ve shown, you can make different kinds of trades to capitalize on the next move from here. In the meantime, keep an eye on the dollar at this important level.
Good trading,
Ben Morris and Drew McConnell
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Source: Daily Wealth