Friday, November 20, 2009
Watching the Dollar for Signs of Stock Market Break Down
As I've been saying for weeks, the key to the stock market rally appears to be the decline in the dollar. As the dollar has fallen, stock prices have rallied. The euro/US dollar, or EUR/USD, is basically the "anti-dollar" and moves opposite the US dollar. So the EUR/USD essentially moves fairly parallel to the stock market. So watching the EUR/USD for signs of a top and break down will give us clues as to when the stock market will top and break down.
Notice on the 4hr EUR/USD chart I have above that the pair has consistantly failed to make a new high recently, despite the Dow and Nasdaqs doing so. Again, another non-confirmation bearish divergence in the markets, indices, and sectors that normally move fairly in line with each other. But more importantly, look at the series of lower highs and lower lows being formed in the very choppy sideways action in the EUR/USD. The market is telling us that the 1.4800 level is VERY important because whenever the pair reaches that level it gets bought up ferociously. But it still keeps inching out new lows before rallying, which ultimately has failed to make new highs. What this probably means is that the bears are slowly and steadily gaining the upper hand here because the bears push the pair down to new lows and then stop a rally to new highs. The more it hits the 1.4800 level, the more erosion to the bulls' support will occur there until eventually there's nothing left. As long as this continues, it's just a matter of time before that support barrier gives way and the EUR/USD collapses. Once that happens, it should move quickly to at least the 1.4650 area before finding support again. So many people are short the dollar and long the EUR/USD that once these people exit, the move will be "jaw-droppingly huge and fast".
When the EUR/USD breaks down, the stock market will follow. The stock market appears to be falling in 5 waves, but probably needs one more "up-down" sequence for the waves to count properly. Otherwise it leaves open the possibility that the entire decline was just an A-B-C drop as shown in red on the attached 15min S&P cash chart.