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The rise and fall of a nation's currency can also be construed as the financial community's vote of confidence. And, the way the USD (US Dollar Index) behaved of late shows a breakdown of this confidence. Chart 1 shows that on Thursday, 9/1/2005, the USD fell below the centerline, the lower band of the Bollinger Band, and the red dotted Parabolic SAR (red circle). Another vote of lack of confidence is in the rising price of Gold. Gold used to have a high degree of inverse correlation with the USD. But, that hasn't always been the case lately. In fact, USD and Gold were in a downtrend together since mid August. But, on Thursday, 9/1/2005, the price of Gold reversed its course and started trending upward (blue circle). Coincidentally, Gold also started a strong uptrend in September last year (blue trendline).
From Chart 2 above, I've also noticed an inverted Head & Shoulders bullish reversal pattern although with the right shoulder stretching out perhaps a little too far. The best way to see this is to flip the chart vertically. This vertically "flipped" chart below (Chart 3) clearly displays the H&S reversal pattern. The right shoulder does stretch a little more than what a typical H&S formation would appear, but it's not totally out of the realm of the technical definition of a H&S pattern. Under the premise that this is still considered a technically sound H&S pattern, the neckline breakout point (breakdown on this vertically flipped chart) should be where the dotted black arrow intersects the price. Visually, it would appear to be somewhere around $448 to $450. I used the conservative $448 for the possible price target count. Adding the distance from the neckline to the Head (blue box) to this breakout point gives us a probable price target of $473.
Let's now flip the chart back to its normal orientation (Chart 4). This is what it should look like normally. Even without all the fancy chart work, the $473 - $475 target seem quite obtainable from the recent development of consecutive higher highs accompanied by higher lows. This forms a very bullish upward price channel.
Next, let's check on the sentiment of the stock market. When I posted this chart (Chart 5) on 8/4/2005, I thought it was odd that the “round-trip” gaps (blue numerals 1 & 2) were not filled while VIX was in an uptrend. But of course, not all gaps have to be filled. It’s just that when they do get filled, they usually signal significant trend changes. This is particularly true on major breakaway or exhaustion gaps. At the time it seemed as though VIX uptrend suddenly came to an abrupt end on 7/7/2005, the day of the London terrorists bombing. Gaps like these usually got filled in a few days unless a new trend had suddenly started. And, back in the early part of summer, there were no technical or fundamental reasons for this kind of drastic trend reversal to take place.
Before we get to the updated chart (Chart 6), let’s pause for some clarification. VIX, for those interested, is the CBOE (Chicago Board Option Exchange) Volatility Index. It measures market’s expectation of near-term volatility of the S&P 500 stock options. The important thing here is that it measures market’s “EXPECTATION”. It doesn't measure the volatility of the stock price swings. It’s about the “IMPLIED” risks associated with the stock market. Generally speaking, a declining stock market is a riskier market where the price of put (to sell stocks) options receive higher premium. And, higher premium means higher implied volatilities. The updated VIX chart (Chart 6) shows that after being put off for about a month, VIX finally got back on track and resumed its uptrend. And, after the market topped out on August 3, 2005, it climbed over the upper edge of the gap (blue line). This gap has now been filled, and it has become the critical support for VIX. Since VIX is a contrarian indicator that has an inverse correlation with the market, this support means resistance for the market. So, as long as VIX stays above this support line, buyers would continue to consider the market risky and stay away. This lack of buying pressure would then prevent the market from further advances. On the other hand, the gap-down that occurred in the middle of May continues to function as an important resistance (red line) as long as this gap is not filled. This resistance of VIX means the Support for the stock market. And, as long as VIX stays below this resistance, there's no "expectation" of big sell-off to violate this support. I know this is counter-intuitive and confusing. But once you get used to thinking in terms of the language of the market, it comes naturally. This is like learning a new language. We have to "think" the language in order to speak and write fluently in that language. And so, between the red and blue lines that I've drawn, lies the great fate of the entire stock market. Since VIX had moved above the blue support line, I would continue to maintain my bearish bias. And, I'll reverse my bearish bias once VIX breaks above the red resistance line.
And, finally, I enclosed the S&P 500 chart in the lower pane of Chart 6 so that you may cross-reference VIX movement with the market movement. You can see that the market has been in a downtrend channel since VIX moved above the blue support line in early August. I've also marked the VIX gap-up in mid April with yellow highlight that matched the bottoming of the market. And when VIX gapped down in mid May, it was when the S&P broke above the previous high (red circle). One more thing... For those of you with keen observation, you might've noticed the "Island Reversal" technical pattern during April and May. I'll leave that technical pattern for future discussion.
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INFORMATION The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
