USD Index - Into the Retracement Zone

The USD Index has corrected sharply lower since it topped out in early June, posting 8 consecutive weekly lower closes adding up to just over an 8% decline in that time. Whilst on the face of it, there seems little love for the USD right now, there are some signs that suggest traders should be on watch for a possible reversal.

Firstly the Head and Shoulder pattern formed through May and June has reached its target. (See chart below).

Secondly the USD index has moved into a Fibonacci Cluster Zone. This is an area of four Fibonacci retracements from four different significant low points to the June 2010 high. (See chart below)

The next chart shows shows how the USD index has moved into a price area that acted as congestion on the way up during February through April this year. This congestion band covers a wide price range, however given the Fibonacci cluster mentioned above, it may not penetrate much further into this zone.  Also notice how there are some early signs that momentum maybe turning up as price moves lower, suggesting this may be forming 'Bullish Divergence. (Click on chart to enlarge).

The next chart shows the USD index at the 174 day simple moving average line. The 174 day sma line has acted as support to large downward corrections of each of the previous strong moves higher since 2004 (Highlighted by the Green arrows on chart). On each occasion the price rejected the 174 day sma, the USD index made strong subsequent advances. [ I have no idea why this particular sma should be significant, other than the fact that 2/3rds of a full trading year is equal to around 174 days.]

One further point; the Large Multi-Year Inverse Head and Shoulder pattern on the USD Index remains a possibility (See chart below) despite the recent setback. However, I also want to draw attention to the major downward trending line (Red line on chart below), which has acted as pivotal resistance on a number of occasions over the past 40 years. This line was always unlikely to yield on a first attempt, but on the two occasions it did eventually yield, the index had initially corrected in the region of 7 - 7.5% before pushing up towards this line again. - The current correction is around 8%, which just keeps it in the ballpark. -- However to play 'devil's advocate', any further correction much below current levels should reduce the chances of a break up through this resistance line and would also suggest the Major Inverse Head and Shoulders pattern may fail.  I would also like to point out that today's monthly close has confirmed a strong Bearish Monthly Candle pattern known as an 'Evening Star Pattern' (See lower chart). Note: the index also produced one of these patterns in late 2008, but that pattern failed to follow through.

(Click on Chart to Enlarge)

It is my Humble opinion that the current level on the USD index may prove to be a bit of a battle ground. I would not be surprised to see a reversal from these levels, at least in the short-term, with its magnitude determining whether it evolves into something much larger. - Should on the other hand USD index continue to decline and break much lower than the current level, it is likely that it could portend further weakness, with this area becoming the first support area of a bigger downtrend.

Spain v Germany - Evening Star pattern on Hourly

Something to keep an eye on. The deterioration in Euro sovereign debt over the past week has been a stronger driver of the risk-off trade of the past few days, with the main focus being the spread between Germany and Spain. However the above hourly chart shows an evening star pattern formed during the past few hours. It is a signal suggesting the first sign a possible pause/correction in this uptrend, and should be watched for any follow through. Note, at this stage the trend remains higher, however a close through the rising trendline, and a lower close than yesterday could change this.

I would also like to note that some of the other usual 'Risk-off' signals, have been fairly relaxed during the most recent sell-off. USDJPY has remained fairly stable, Gold & Silver remain 'bid to old boots', and Libors appear very relaxed. I am questioning whether the 'Risk-off' trade may be due for another pause.