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Low Risk Opportunity for Dollar Traders...

Clive Maund
1 November, 2004

The reason for this short article is to highlight the current exceptionally favourable risk/reward ratio on offer to short-term dollar traders.

Having broken key support at 87 on the index, the dollar plunged during October to the next important support level, and is now, as a result, quite deeply oversold. At first I believed that it may form a brief sideways flag or pennant formation, to partially alleviate the oversold condition, before breaking down again. However, the price action of the past several days points to the likelihood of some kind of rally over the short-term and, of course, this may still take the form of a counter-trending flag or pennant. The point is that it looks like some kind of rally is brewing, and it should be of sufficient size for agile dollar traders to scalp a good, quick profit, and with the stop-loss position very close, the risk/reward ratio is unusually favourable.

The recent plunge to the clear and important support at the lows of last January and February, and the resulting oversold condition, is plain to see on the 1-year chart, and it is normal to expect either a counter-trend rally or a narrow trading range to develop above this support before the larger downtrend resumes.

Close examination of the action of recent days suggests that a short-term low is in, and that some kind of rally is brewing. To examine the price action of recent days in detail, we will look at a 1-month chart. On this chart we can see in detail the downtrend following the failure of the support at 87, and the stabilisation in recent days as the support level was met. On Wednesday, a clear "Hammer" candlestick formed, and when one of these appears following a substantial downtrend it is normally a warning of a reversal of trend, at least over the short-term.

But first, following the appearance of the hammer, prices frequently return to the vicinity of the bottom of the hammer before turning up again - this is what happened on Friday. When this happens it throws up an optimal buy-spot, enabling positions to be taken with a very tight stop just beneath the low end of the hammer, affording an excellent risk/reward ratio, as the position can be immediately exited on a break below the low end of the hammer for a trivial loss, as a break below this point would be bearish, opening up the prospect of another sharp decline. Although in this case we have to bear in mind the nearby underlying support arising from the lows of last January and February.

Obviously, if the dollar stages some kind of rally from here it can be expected to result in gold and silver backing off. The MAXIMUM upside for the dollar on a short-term rally is the 87 area, as what was support for the dollar is now resistance, although it is considered to be unlikely that it will get that far. After such a rally has run its course, it should turn lower and challenge the support in the 84.60 - 85 area once again, and this time should break below it. Therefore, a short-term dollar rally is expected to present a further opportunity to accumulate gold and silver stocks ahead of a gold breakout above $430. In the meantime, agile dollar traders have the opportunity to turn a quick, low-risk profit, by going long now with a stop below about 84.60, or last February's low and bailing as 87 is approached, or as the rally appears to run out of steam.

Finally, like all technical patterns, the hammer formation does not indicate the future trend with certainty - the dollar may simply break down, although the probability is that it will rally from here. I am sure readers are well aware that I will not be too upset if this prediction does not work out.

Clive Maund

Clive Maund is an English technical analyst, holding a diploma from the Society of Technical Analysts, Cambridge and living in southern Bavaria, Germany where he trades US markets.

Visit his subscription website at clivemaund.com.[You can subscribe here].

No responsibility can be accepted for losses that may result as a consequence of trading on the basis of this analysis.

Copyright © 2003-2004 CliveMaund. All Rights Reserved.

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