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Why It's Risky to Be Short the Dollar or Long the Euro


The dollar's behavior will likely reveal whether traders should look for upward continuation in the euro or instead be poised to take advantage of a reversal.

Charting the Dollar Index is useful for several reasons. First, there is a futures contract that's tied to the index. Beyond that, understanding what the dollar is doing assists in identifying trading opportunities in other currencies such as the euro, and it aids in forecasting the broad direction of equity markets.

Right now, the Dollar Index is at an area of likely support. At the very least, it is near an important decision area. On the monthly time frame, the dollar is testing what might become the lower boundary of a developing channel. In addition, the dominant 49-week price cycle is currently directed upward, increasing the probability of a bounce from support.

From an Elliott Wave perspective, the downward move of recent months fits well as a retrace, or perhaps the first part of a retrace, working toward developing a platform for an eventual launch to much higher levels. This scenario is our primary one, and it is quite bullish for the dollar, as it implies that price might be seeking a base to begin an upward third wave '(iii)' inside a larger upward third wave or C-wave.

However, with this bullish scenario, it is not clear that the dollar is ready to climb up in a '3' or 'C' just yet. The corrective retrace may not be complete. For example, it could require a modest bounce and then another move downward before price is ready to begin an impulsive move upward.

The weekly chart for the dollar provides a clearer picture of the retrace and the path that a continued correction might take. The impression is that the retrace is not yet complete. However, a bounce as a '(b)' wave could easily reach one of the targets shown (80.65, 81.71, 82.48, and 83.44). If price continues upward beyond the levels shown, then odds increase that the retrace is over. The move is tradable in either case.

Our alternate scenario also is bullish for the dollar in the long term, but it calls for price to head lower first, perhaps through much of 2013. In this view, price may be trying to complete the last segment of an ending diagonal formation, which of course would be followed by a lengthy period, probably several years, when the tendency would be upward.

Thus, the dollar's behavior at the potential channel boundary on the monthly chart will probably reveal whether traders should look for upward continuation in the euro or instead be poised to take advantage of a reversal.

As we said, understanding the dollar provides an edge in other trading decisions. We watch the US Dollar Index closely as a tool for indentifying or confirming trades in the euro as well as other markets. The Dollar Index values the US dollar based on a basket of currencies, and the inverse of the euro constitutes 57.6% of the value of the Dollar Index. In most cases, to be able to trade one is to be able to trade the other.

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