Why the Market Never Rewards the Popular Trade

My last update on the U.S. dollar was on May 1. At the time, I wrote that increased volatility in the dollar was just around the corner.

Specifically, I warned readers that the dollar was going to have its next big move on May 3.

On May 4, the dollar index (DXY) bottomed out and hasn’t looked back since.

DXY had traced out a large head and shoulders pattern, a classic bear market setup. The only problem, however, is that everyone was talking about it.

In other words, it was too obvious.

And as Jeff Clark and I like to say, the market rarely rewards the obvious trade. That was the problem with the bearish case for the dollar.

This was a move that took currency traders by complete surprise. Almost everyone was expecting the dollar to break down in a big way.

But in that May 1 issue, I wrote that “it’s also very possible that dollar bulls will step in to defend the currency, negating the bearish potential of this pattern.”

That’s exactly what’s happened… but now, I see some potential storm clouds on the horizon.

It might just be dollar bulls that are about to get smacked around next.

Let me walk you through an updated price chart of DXY so I can show you what I mean.

Here’s what’s going on with DXY…

There’s an important resistance zone coming up soon. The zone spans a rough range between 105.20 and 105.65.

This area should be a very stiff test for dollar bulls.

If bears are able to defend the zone, then it’s likely DXY crashes back through the neckline of the larger head and shoulders pattern I’d identified earlier. This would mean serious dollar weakness in the weeks and months ahead.

On the other hand, if bulls can convincingly break out of the zone, it opens the door to a much stronger dollar.

Sometimes the technical picture is clear enough for me to tell you which scenario is more likely to happen.

But the truth is, I think this as close to a coin flip as it gets.

It wasn’t that long ago the market was hopeful inflation had peaked and the Fed was getting closer to a potential shift in policy.

But recent economic data paints a different picture. For example, consumer prices rose in April relative to where they were in March. And Friday’s payroll reports were much better than expected, highlighting a resilient labor market.

Simply put, the market’s not sure whether the Fed can afford to pivot any time soon. And hawkish monetary policy is generally supportive of a strong dollar.

That’s why I’m going to lean on technical analysis to point the way for what’s coming next in the currency markets.

As soon as the dollar makes up its mind, I’ll have an update for you right here.

Until then, happy trading.

Imre Gams

Are you hopeful that inflation has peaked, or do you think there’s more pain ahead?

Let us know your thoughts – and any questions you have – at [email protected].