Reversal In The Dollar And How You Can Profit

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Reversal In The Dollar And How You Can Profit

The Trade War Escalates

Over the course of the last week the dollar has shot to a new high, hit resistance, and fallen back to support. The move was driven by data, shifting FOMC policy outlook, the FOMC statement, and now, escalating trade war conditions. What we have for certain is a dollar with increasing volatility, the ultimate direction of that volatility is yet to be determined. The underlying fundamentals scream for a stronger dollar, the U.S. economy has so far been resilient while that of the EU, UK and Japan less so. The risk is that, with the new round of tit-for-tariff, the U.S. economy will begin to fell more pain.

This week there is virtually no economic data to sway the market. There is some, don’t get me wrong, but no piece is that important, important enough to shape the market’s outlook and assuage fear of global slowdown. For now, the DXY is still above support and looks like it is in an upwardly biased trend. The index is above the top of a previous range and the indicators are consistent with underlying strength if not upward continuation of trend. The $97.50 looks like a good entry point for new positions, the index may bounce from this level or fall through. A bounce is likely to move up and retest $98.50, a break through of support could lead the index down to $97.50 or $96.00.

The EUR/USD has effected what looks like a nice rebound/reversal in prices. I will caution you though, the pair is merely retracing a recent fall through support to retest resistance at that previous support level. The long-term outlook is for the dollar to appreciate because the EU economic slowdown is worse than in the U.S., the ECB is still expected to reduce rates and stimulate the economy, the FOMC is no longer expected to cut rates three times this year, and the Brexit is coming up. Resistance should be near 1.2000, once confirmed look for the EUR/USD to fall back toward 1.105. If the pair breaks through support a move to 1.2910 is possible.

The USD/JPY sank to a new long-term low in early Monday trading as safe-haven inflows drive the yen. The pair is heading down toward the 105.00 region where it is likely to bounce. This level has provided strong support in the past and there is still dollar strength to consider. Safe-haven inflows can only suppress this currency for so long. Longer-term, I expect the USD/JPY will continue to trade sideways within its multiyear range.

Trading the NFP V-Shaped Reversal

As many experienced traders have learned, the NFP report is notoriously difficult to trade successfully. For one, the headline employment number is particularly difficult to predict due to the high margin for error. Counter-intuitively, a strong report often leads to weakness in the U.S. dollar (USD). This is because a large increase in U.S. employment is indicative of a growing global economy, which can prompt traders to sell safe-haven currencies like the U.S. dollar and buy higher-yielding currencies from other regions.

What causes the V?

Typically, economic releases lead to relatively straightforward outcomes in the market. For instance, if GDP growth expands more quickly than expected in Australia, the Australian dollar (AUD) will rally the vast majority of the time. The NFP report, on the other hand, is infamous for “V-shaped” reversals in the wake of the release, where the market initially spikes sharply in one direction before reversing in the following 10-120 minutes and heading in the other direction for the remainder of the day.

EUR/USD (5 minute chart)

So how do you trade the V?

Rather than trying to anticipate both the NFP number and the market’s reaction, wait until after initial volatility in the wake of the release settles down and try to catch the V-shaped reversal, which could offer a very favorable risk-to-reward ratio on a trade.

Though a reversal is not inevitable (nothing in trading is), even catching a reversal 33% of the time can lead to a profit if the trader utilizes a strong risk-to-reward ratio. To further improve the probability of catching a reversal, traders should wait for a reversal candlestick pattern on the 5-minute or 15-minute chart.

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An example trade

For a quick example, let’s look at the chart below. The NFP report printed at 146k, handily beating expectations of 89k. After initially dropping about 35 pips in the first 10 minutes, the EUR/USD put in a Bullish Pin Candle on the 5min chart, suggesting a possible shift from selling to buying pressure.

This candlestick pattern was the signal to get into the trade; an entry near the close of the candle (around 1.2890) with a tight stop below the low (near 1.2875) would have given a low 15 pips of risk. As we can see, the pair eventually rallied all the way up to 1.2950, over 60 pips above the entry signal.

While not all NFP reports will lead to such a sharp reversal (and traders generally won’t capture every pip of potential profit), this style of trading could offer trades with strong risk-to-reward ratios, allowing you to trade NFP without having to guess at the number or its market impact.

How to Profit From a Reversal in the Dollar

A stronger U.S. economy and its status as a safe-haven currency have helped the U.S. dollar strengthen in recent months as other major currencies such as the euro, Japanese yen, and British pound have slumped. But the mighty dollar could be set for a sharp reversal in the months ahead. The Federal Reserve’s latest actions to purchase bonds and mortgage securities is increasing the supply of dollars. At the same time, the coming fiscal cliff threatens to put the kibosh on America’s nascent economic recovery, which could spur even more dollar-deflationary action from the Fed.

In today’s video, Matt and Paul discuss the potential for a weaker dollar and what it could mean for investors. They also share a few investment ideas that could actually benefit from a declining dollar. What the following video to get the names.

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The article How to Profit From a Reversal in the Dollar originally appeared on Fool.com.

Matthew Argersinger owns shares of MercadoLibre. Paul Chi owns shares of Arcos Dorados and has options on Arcos Dorados. The Motley Fool owns shares of Arcos Dorados, McDonald’s, and MercadoLibre. Motley Fool newsletter services recommend McDonald’s and MercadoLibre. Try any of our Foolish newsletter services free for 30 days. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 – 2020 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.

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