What I am not writing about

What I am writing about …

While ever so slight, the US dollar index closed just below critical prior swing low support level a week ago and then immediately reversed higher closing back into the channel on Friday. While volume is not available as this is not a tradeable index, using the tradeable proxy (UUP) the reversal occurred on almost 2x the volume.

Bear Trap Definition - A bear trap occurs when shorts take on a position when an investment is breaking down, only to have it reverse and shoot higher.  This counter move produces a trap and often leads to sharp rallies.

With this weeks close back into the consolidation channel and combined with a higher close next week, this latest move could be a classic example of a bear trap. If so, I would expect we see a sharp rally in the coming weeks carrying the potential for the index to break out above the most recent 100-101 swing high.

Why do Bear Traps produce sharp rallies? - The first wave of buying will occur when the most recent broken support level is exceeded, due to the number of shorter term traders who have their stops slightly above the most recent swing high. The second wave of buying comes into play once the stronger realize that it is not just a dead cat bounce, but that the move has much bigger potential. This will produce the second bounce, which will often precede the short-term top in the counter move.

If all this talk about bear traps sounds vaguely familiar, it should. I wrote about another potential bear trap in the mining stocks back in February. Since that bear trap, the GDX has rallied almost 100%. Now, I am not saying the dollar will rally 100%, as that is all but impossible, but if this does turn out to be a bear trap the implications are enormous. A strong dollar can push bond prices higher (yields lower), make the recent rally in commodities, precious metals, emerging markets and large cap US stocks (with large foreign sales) a thing of the past as these typically move inversely to the dollar. Sure, money can be made by being long the dollar but it will pale in comparison to those who short those falling inversely correlated investments.

There are no guarantees, but if the dollar breaks higher, this is setting up to one be the best money making opportunities this year. Stay tuned as the next few weeks is going to get really interesting.