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Dollar Doom?

Dollar Doom?

DailyFX, Research

Choosing the right currency for your strategy is an often overlooked element of a trading plan. Today, we will look at the relative strength of non USD currencies to help us determine which one to pair up with the US Dollar to trade.

(Created using FXCM’s Marketscope 2.0 charts)

The US Dollar has been weakening on the doorstep of a historic FOMC announcement this afternoon. This is a widely anticipated announcement as there is great speculation as to why the Fed Chairman Bernanke would call a press conference when this has never been done before. Is it possible the announcement could bring new information regarding a medium term direction for the US Dollar? Will this information be dollar bearish where the trend continues or dollar bullish as the fundamentals shift? Before we find out, let’s begin to develop our strategy based on technical analysis.

The US Dollar Index chart above is approaching a zone which may provide some support for the single currency. How prices behave around this support zone (73.00 – 73.35) may indicate which currency pair we trade. Let’s look at the trends of individual pairs for year to date 2011.

% change-9%+1%-6%-6%-5%-4%-4%
% change-4%-9%-9%-1%+1%-9%-6%

(The percentages above represent the percentage change of the USD during the 2011 calendar year.)

The figures above represent how the US Dollar performed in that specific pair. For example, when you see EURUSD -9%, that means the US Dollar has weakened 9% against the Euro. The USDJPY has +1% and that means the US Dollar has gained 1% on the Japanese Yen.

US Dollar Bearish Case

If the US Dollar continues to fall and break through support, it would make sense to trade a pair that the US Dollar has been the weakest against. This means we would consider the yellow highlighted pairs to trade USD weakness.

The EURUSD has zoomed higher even as traders continue to sell the pair short. The recent ECB rate hike has provided some fuel for the move. It is currently in a series of higher highs and higher lows so look for a break out trade going long (meaning US Dollar weakness). Use the current high of 1.4716 as the entry point and place a stop just below the swing low. Look for twice the distance to your stop as your profit target.

(Created using FXCM’s Marketscope 2.0 charts)

US Dollar Bullish Case

If the US Dollar finds support and builds up a rally, it would make sense to trade a pair that has been challenged to rally versus the world’s reserve currency. The Japanese Yen and South African Rand (green highlights above) have actually lost ground versus the greenback so far this year. This means the US Dollar has already rallied against the JPY and ZAR., so further Dollar strength could propel these exchange rates higher in favor of the greenback.

(Created using FXCM’s Marketscope 2.0 charts)

One way to trade this is by making a breakout trade going long above the 83.30 level on the USDJPY. That would temporarily re-instate a series of higher highs. Place a stop just below the swing low and look to take profits at least twice the distance to the stop.

Jeremy Wagner contributes to the Instructor Trading Tips articles.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.