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The election aftermath unleashed huge moves across the markets.
Stocks, interest rates, and cryptocurrencies have seen big reactions as investors try to digest the outcome.
But one trade is showing signs of exhaustion… The U.S. dollar.
The dollar jumped higher against other currencies following the news that Donald Trump was the new president-elect.
But now the dollar is coming up on a key chart level.
A pattern is emerging that has led to a major reversal on several occasions over the past year.
So today, let’s discuss what I’m watching… and why the dollar’s rally could stall out…
The Dollar Is Approaching a Key Level
Over my 40-year career, I’ve traded nearly a trillion dollars’ worth of currencies.
The currency market is huge, with roughly $7.5 trillion in currency trades happening every single day.
And the U.S. dollar factors into nearly 90% of all foreign exchange transactions, making it the world’s dominant currency.
That’s why it’s important to pay close attention to the U.S. Dollar Index (DXY). It tracks the dollar’s performance against a basket of other currencies.
After peaking in September 2022, DXY fell toward the 100 level in early 2023.
Since then, the dollar has traded in a wide range, as you can see in the shaded area of the chart below.
That trading range saw support at the 100 level on the low end. The 106 level has served as resistance on the high end.
At the end of September, the dollar tested support yet again at the 100 level (the arrow). The most recent dollar rally followed that test of support.
That rally picked up steam following the election and has brought DXY right back to its key resistance level.
At the same, I see a warning sign flashing that a reversal could be in store…
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A Reversal Signal
Since early 2023, the dollar has experienced several major reversals inside its trading range.
And one key chart indicator has hinted at those reversals over the past year.
I’m talking about “momentum divergences” with the Relative Strength Index (RSI). The RSI measures changes in underlying price momentum.
A divergence develops when the RSI stops confirming a price trend. In other words, notice when a stock is moving up but the RSI is falling – and vice versa.
Those signals take on increasing significance when a divergence occurs at a key chart level.
Take another look at the DXY chart.
Points A and B on the chart show tests of resistance at the high end of the range. During those tests, the RSI made a negative divergence with a lower high (see first and third dashed lines).
Points C and D on the chart show tests of support at the low end of the range. In those tests, the RSI made a positive divergence by making a higher low (see second and fourth dashed lines).
In each instance when DXY has tested the extremes of its trading range alongside an RSI divergence, a reversal has occurred.
Now look at the DXY chart one more time…
Following the post-election gain, DXY is approaching resistance (the arrow).
But look at what is happening with the RSI. It’s making a negative divergence with a lower high.
There’s no guarantee that the dollar will see a major reversal this time around.
But the warning signs are suggesting the dollar’s rally will soon run out of steam… and that could be a profitable play for traders who are paying attention…
Regards,
Larry Benedict
Editor, Trading With Larry Benedict