Last month the US Dollar was stopped out by my SSI stop loss indicator. I think it might be a bear trap.
A bear trap happens when an asset moves just beyond where a majority of market players believe the big support lies. Price breaks through that support and draws in the market bears who are hungry for lower prices to come.
Instead of price following through to the downside, however, price reverses sharply higher and acts like a trap snapping shut on the bears. The bears have to cover their short positions as price moves higher. That sends prices upward with even more strength since the bears need to buy back the asset to close their short positions.
Before I get to why I think we might be looking at a bear trap in the dollar, let me show you what our SSI indicators have to say about the dollar.
The current volatility quotient (VQ) on the US Dollar is 5.7%. The Dollar originally corrected more than 5.7% back in early 2015. It then went sideways for a while, rallied again, triggering a new entry signal, only to get stopped out by another 5.7% correction last month.
This kind of whipsaw action is definitely frustrating, but it happens sometimes … and I’m concerned that it might be about to happen again. Here’s why.
There are two reasons that I believe that the dollar may yet soon be headed higher. The first reason is that the commercial hedgers (from the commercial commitment of traders data) are increasingly bullish. These commercial hedgers are traditionally referred to as the “smart money” … and for good reason. They have a better understanding of their markets than almost anyone else.
The chart below shows how the commercial hedgers (bottom section of the chart) had their biggest short position in the US dollar in years as of early 2015. They were net short nearly 100,000 futures contracts.
Over the past year, however, they have been buying back those short hedges and are now nearly back to a neutral position near the zero line (“00K” on the above chart).
The red ovals in the chart above show what has happened in the past when these commercial hedgers have reached a peak in their hedging strategies at or above the zero line. It has regularly indicated significant bottoms in the US dollar.
My second big concern about the bear case for the US dollar comes from my proprietary time-cycles analysis. While the cycle peaks and troughs have sometimes been off by a few months, they’ve been pretty reliable for the past 10 years.
Today the cycles suggest a big bottom in early 2016 followed by a big rally through late 2016.
The fate of the US dollar has major repercussions for many other asset classes – particularly commodities. The following chart shows how the dollars moves have been correlated to other commodities like gold, silver and oil.
Gold and silver both turned down at the exact moment that the dollar recently turned up … and while oil hasn’t turned down (yet), the rate of its ascent has definitely slowed with the dollar’s rise.
A strong dollar is not only a threat to commodities, but also to emerging markets. Much of the world’s debt is priced in US dollars. As the US dollar gets stronger, it becomes more expensive to get the dollars to pay back the dollar-denominated debt.
That could be a nightmare scenario for many of the world’s economies and is a big reason why the US Federal Reserve has been resisting further short-term interest rate hikes.
So yes, the dollar got stopped out by our SSI system and it even dipped very briefly below it’s unmistakable horizontal support (see second chart above). But the dollar has rallied sharply in the month of May and there continue to be serious reasons to doubt the bear case for the US dollar.
That’s a recipe for a bear trap. The bears have been warned,
Richard M. Smith, PhD
CEO & Founder, TradeStops