Bullish Divergence Still Building on US Dollar Index

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I made this chart earlier today, so it doesn't include today's price on there, but I have indicated it with the thin blue line at 75.68. It has the largest white real body since August. Also it closed right near the highs showing that dollar bulls owned the close. Coming off a low like this, I think it would be very rare to not have some more strength to follow if only for a few day. However, a clear close above $77 especially if it happens in the next few days would be a higher high and potentially reverse the down trend to some degree.

I post a fair amount on the dollar because basically all major investment classes seem to be keying off the dollar and the dollar value is a fundamental issue at play in our struggling economy. Also, anyone who has done a reasonable amount of reading on the issue is likely to be familiar with the term "carry trade" as pertains to currencies and that the US dollar is the carry trade du jour. For those that are not familiar with this term, it means that currency investors are converting/selling the US dollar which has a very low interest rate and buying other currencies that have higher interest rates. That way they are able to profit from the yield difference of the stronger currency minus the weaker. The carry trade is certainly most beneficial to initiate against the weak currency early in a phase of interest rate deductions. However, when interest rates near zero, the potential risk of interest rate hikes start to obviously become a greater risk.

In some ways an immense carry trade against the dollar is akin to a huge amount of short interest in a stock. For those who understand what a short squeeze is in a stock, you may know how explosive price rebounds are in those cases. When a carry trade unwinds in a currency it is similar in that the move in the currency tends to be very explosive. Also, the leverage factor available in currency trading is much larger compared to stocks, and so the effect of say a 5% move in the currency market probably will have several times that % impact on equities.

The point I'm making here is that there is indeed a carry trade against the dollar. At some point, it is likely to be unloaded, and that could lead to declines in the market value of other dollar denominated assets like stocks, oil and commodities, etc as the dollar gains value.

Now the great thing about technical analysis is that you don't really need to know any of that type of thing or have to guess when it will happen. Often the indicators will show glaring signs of a trend that is weakening or slowing. The chart above shows a major divergence in most oscillators. The oscillators are making higher lows on each of the last 2 new price lows. The trend indicators have weakened quite a bit in recent months/weeks, so that they could turn bullish relatively quickly on the USD.

On stocks you can find data like short interest relative to total float, short interest change over a certain time frame, short interest divided by average volume which gives you an approximate # of days to cover the entire short interest, etc. That can help you determine which stocks are heavily shorted and have explosive potential at market turns. Also, with detailed data you can approximate the average price of the entire short interest which can be used as a squeeze trigger point, because if price rises to that point then the total short interest will collectively be at a loss and force a large amount of shares to be bought to cover as price rises further. That can lead to very heavy excess buying demand at times and lead to explosive price moves.

I inquired with Sentimentrader.com about if there was any data accessible as far as quantifying the carry trade on the dollar in hopes of being able to get some more detail about the USD dynamics akin to that described above on stocks. But he didn't really have anything to offer on that, and I don't know what kind of data is available. So right now I would just say, that I think there is the potential to what amounts to a huge short covering rally on the USD.

So that is just a little more background on the rationale for continuing to take bullish trading opportunities on the USD despite that several have been stopped out in recent months. I know it can seem stupid when you've been stopped out several times, but I think persistence will pay off in this case.