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The European Central Bank announced two weeks ago it would cut the level of bonds it purchases every month but extend the length of time it would continue to buy them. That sparked an upside breakout in the U.S. Dollar Index and gave the dollar bulls room to run.

In round numbers, the greenback targets 97.50 from current 95.00. That may not seem to be much of a move, but in the currency markets it is significant. The dollar is down 12.4% from its Jan 3. Peak to its Sept 8. low—and is still down 8.8% year to date.
The U.S. Dollar Index tracks the dollar’s performance versus a trade-weighted basket of other currencies; the euro represents 57.6% of its value. Since movements in the dollar are usually the inverse of movements in the euro, it was clearly the euro weakness after the ECB announcement that triggered the dollar’s breakout.

The dollar also looks strong against other currencies in the basket, including the Japanese yen (13.6% weight), Canadian dollar (9.1%), Swedish krona (4.2%), and Swiss franc (3.6%).

Thanks to the ECB news, the chart of the dollar index shows simultaneous upside breakouts Oct. 26 from two distinct technical features (see Chart 1). Investors can also track the dollar’s performance with the PowerShares DB US Dollar Index Bullish exchange-traded fund (ticker: UUP).

Chart 1


 
The first feature is the declining trend drawn from March of this year. Admittedly, the line I drew is somewhat subjective, as it missed a few of the data points normally included. Yet the spirit of the line is sound, so the conclusion of a breakout is valid.

The second feature is an inverted, or upside-down, head-and-shoulders pattern—a formation that shows a gradual change from a bearish trend to a bullish one. It completed when the market moved above its upper border, better known as the “neckline.”

There are other wonky technicals that foreshadowed this breakout, including a failed breakdown below long-term chart support in September and rising momentum readings over the past few months.

Chart watchers use the size of technical patterns to forecast likely targets once the breakout occurs.

Measured from the lowest point in the pattern to the neckline, the pattern measures approximately 3.10 points. Add that to the breakout point, at 94.40, to get a first upside target of 97.50.

The euro shows the opposite trend, with a breakdown from its own head-and-shoulders pattern (see Chart 2). Using the CurrencyShares Euro Trust ETF (FXE) as a proxy, the breakdown targets the $109.50 level from its recent price of $111.90.

Chart 2


 
Proving that the euro and dollar index are not exact opposites, the trendline in the euro ETF is much less subjective in terms of its construction. This line broke to the downside in September.
 
The time frame for these moves is on the order of weeks, and is relatively short-term in nature. But there is an argument for a longer-term move.
 
For the dollar, there was a trading range in effect for the past few years, with the notable exception of the September false breakdown and the much longer-lived false upside breakout late last year (see Chart 3). Should the short-term rally reach its target of 97.50, we can reevaluate to see if the dollar is strong enough to target the top of that former range in the 100.50 area.

Chart 3



Let’s make that call if and when the dollar reaches 97.50.

The only major currency that is currently beating the dollar is the cryptocurrency bitcoin, but that deserves full treatment in another column.

For now, the dollar seems to be the fiat currency of choice among the major currencies—and even among emerging currencies in Brazil, Turkey, South Africa, and Russia.


Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.