The dollar index is made up of a basket of 6 currencies:

1. Euro – 57.6%
2. Japanese Yen – 13.6%
3. Sterling Pound – 11.9%
4. Canadian Dollar – 9.1%
5. Swedish Krona – 4.2%
6. Swiss Franc – 3.6%

The current weight was fixed since 1999.

Attached is a chart of the Dollar Index (DX). Its direction is unclear but a more definitive picture should be available in a couple of days only.

Multiple Time Frame Analysis is a very important technical study to master for FX trading.

The principle to follow in Multiple Time Frame Analysis is this: the chart in the higher time frame shows the larger picture or trend. It is stronger and will have influence on the lower time frame. It is therefore good practice to have a top down approach to analyze a particular chart.

As an illustration, let’s look at the weekly chart of USDX.

USDX Weekly shows a long tail doji resting on the top of a channel

From the chart above, USDX has a rally which seems to be defined by a price channel. Last week’s candlestick showed a long tailed doji star.

This two observations allow us to put together this picture:

1. USDX will continue its uptrend as long as it stays in the channel
2. Channel lows are supports, they are good retracement levels to go long
3. Channel highs are resistances, they are good profit taking levels
4. Doji star shows bulls struggling and the entry of bears

As this doji star was on a weekly chart, we can see that it can be broken down into 5 daily candles.

5 Daily Candlesticks make 1 Weekly Candlestick

To continue our multiple time frame analysis, we recall that it is good practice to have a top-down approach. So lets start by doing the weekly analysis.

Weekly Analysis 15 – 19 February 2010

Last week’s candlestick ended as a long tailed doji star. It means that the weekly charts might predict profit taking although the daily charts could show a reversal pattern. As the doji star was on the top of the price channel, this reinforces the likelihood that the USDX might take a respite from its rally.

Daily Analysis

We cascade down to inspect the daily movement of the USDX in the same week. Candles show big swings and had twice 1 day reversals (see 16-17 Feb and 18-19 Feb), which simply reflect the market’s indecision.

Putting together the two analyses, traders could do the following:

1. Because we are at the top of the weekly channel, any signal could be used for profit taking for the bull
2. Nimble traders could step in for a quick counter trend short in the lower time frame
3. Uncommitted bulls can also use any support in the day chart to buy but the optimum buy zone is the channel low in the weekly picture.

Conclusion

The higher time frame will provide a clear picture of the prevailing trend as well as show strong boundaries. These are the support and resistance and will clearly dictate movement of less committed traders using the lower time frame picture. While currency traders are unlikely to be trading the weekly charts, the concepts and principles covered here are equally applicable to other pairing time frames such as the 1-hour/4-hour or the 15-min/60-min.

When the 1-hour and the 4-hour charts are paired, the 4-hour chart gives the larger and stronger picture. When the 15-min and the 60-min charts are paired, the 60-min chart gives the larger and stronger picture as well.

For the past 2 weeks or so, we are seeing the US Dollar Index moving in a trading range, which also defines its current support and resistance level.

The COT Report released last Fri points to a slightly lower Total Open Interest and a slight unwinding of the shorts of the Net Commercial Sentiments.

The trading range seems to be a consolidation after the recent rally after the bull flag in Jan 2010.

Lastly, it is noted that the upward trend of USDX seems to be strong as it is yet to be violated.

From Last Friday’s COT Report, the Commercial Net Position has moved down to the level near Jan 2010, a net short level which is unseen for the past 5 years.

In addition, the Total Open Interest remains on a high level. Together, these indicate that the current uptrend for USDX remains strong.

Today, we are analyzing chart patterns in the Dollar Index (USDX) together with the COT Report in order to finds that may tell us where the dollar is going.

Breakout in weekly chart

In my post Reflection on FX Majors with COT Report, we already know that USDX has recently made a breakout of the falling wedge pattern in the weekly chart (See chart below).

We also see that USDX is trading between a recent Resistance @ 78.82 and Support @ 76.22 and is currently near the resistance level.

USDX Weekly Showing Bullish Reversal Breakout of Falling Wedge

Daily Chart – 1. Bullish Flag Pattern

From the daily chart below that there is a Bullish Flag Pattern, which was formed shortly after the breakout from the falling wedge pattern on the weekly chart.

In addition, the flag was ‘resting’ on the 50 day Moving Average, forming a Higher Low, thereby giving some bullishness to the picture of USDX.

USDX Bullish Flag

On the other hand, some might consider another outlook for the USDX in the manner below.

Daily Chart – 2. Bearish Broadening Top Pattern

USDX Bearish Broadening Top Pattern

As from the  chart above, a different way of joining the resistance line gives us a broadening top chart pattern, which might indicate a somewhat bearish view.

The recent shooting star, which happens to be near the previous monthly resistance, adds to the bearish-ness on the current movement. (See chart below)

USDX Bearish Shooting Star Candlestick

There are two pictures now, a Bullish Flag Pattern and a Bearish Broadening Top Pattern.

So how can we resolve this 2 conflicting views? The COT Report comes into the picture.

COT Report Analysis

With reference to the above charts, the bottom panel of the chart maps the Total Open Interest and the Commercial Sentiments for USDX.

We can see that:

• Commercial Sentiments is unwinding their shorts on USDX, which may indicate slightly bullish sentiments.
• The total Open Interest is slightly lower than previous week, which also hints that there is still high interest for USDX, thus, boosting the bullish signal again!

Yesterday, we saw big moves for all Majors Currencies. Looking at yesterday’s post on USDCHF throwback in day chart; hourly chart expansion gains, there seems to be a correlation of the Dollar Index, commonly known as USDX, with all cross-pairs of the USD.

Let’s have a look at the COT Report posted last Friday, 15 Jan, to see if there is any signs that the big players have left trails.

It can be seen that there was a support for USDX at 74.12, and a Big falling wedge pattern formed since Mar 09 till now.
The breakout from the wedge following with the breakout to above 50 day moving average,  suggest that a bullish trend reversal is intact, thus, USDX is likely to trend upwards.

From the COT Indicators, our interest is to look at the Net Position of the Commercial Traders and the Total Open Interest. Commercial Trader are the Big Boys and the Smart Money as discussed in my previous post and thus the Total Open Interest will also reflect largely on their open positions.  We see that the Net Position of the Commercials were on the extreme short position seen at the previous week, and they were unwinding their shorts position slowly as from last week. It is the similar pattern last seen in 3rd quarter of 2008, and causing a bull rally on the USDX.

The USDX is an index of Major Currencies and  therefore the chart pattern seen on USDX is similar with those pairs with USD as its base currency, eg. USD/CHF, USD/JPY and USD/CAD.

So which will move first? The USDX or the cross pairs in the spot market? I might find an  answer to this when somebody can tell me which come first: ‘The chicken or the egg’?

At the end of day, we should be traders first, investor second, and ride on the trend as long as possible.

The Swissy did a throwback on the day chart. From the hourly chart, it is clearly expanding after base building. Are dollar gains here to stay? DX chart from Ino.com. The USDJPY is making similar move.

Throwback in Swissy after breakout from downtrend

Beautiful base building in hourly chart

Dollar gains visible in DX

Throwback move is also mirrored in USDJPY while a wedge formation reinforces the view of a possible continuation move.

Throwback and wedge reinforces USDJPY continuation

The US Dollar has risen broadly against major currencies. This is especially true for the Euro and the Swiss Franc. A measure of its success can be seen in the US Dollar Index (DX) which looks at the value of the US Dollar against a basket of foreign currencies.

Wikipedia gives a very good explanation of the index.

It is a weighted geometric mean of the dollar’s value compared only with

• Euro (EUR), 57.6% weight
• Japanese yen (JPY), 13.6% weight
• Pound sterling (GBP), 11.9% weight
• Canadian dollar (CAD), 9.1% weight
• Swedish krona (SEK), 4.2% weight
• Swiss franc (CHF) 3.6% weight.

2 aspects are notable:

1. It was started in March 1973.
2. It has only been changed once in 1999.

This makes the index an important tool in the trader’s toolbox. The index can also be traded. A chart of the dollar index can be found here at Ino.com

US Dollar Index: DX