THE US DOLLAR IS AN EXCELLENT TRENDING VEHICLE THAT CHARTS EXTREMELY WELL -- PROFUNDS OFFERS A COUPLE OF DOLLAR FUNDS FOR TRADING OR HEDGING PURPOSES
LONG-TERM DOLLAR VIEW ... I've long maintained that currency markets represent a separate asset class that most investors don't participate in. Institutions can and do trade cash currencies through interbank arrangements. Futures and options traders can trade foreign currencies on the Chicago Mercantile Exchange or the Dollar Index on the New York Board of Trade. It's not so easy for the average investor to participate in currency swings. That may be changing. Before we get to that, however, let's look at the performance of the U.S. Dollar Index over several time frames. If you get the impression that the dollar (and currencies in general) chart very well, you'd be correct. Currency markets have strong trending characteristics. That means that when they start a trend, that trend tends to last. That's especially good for trend-followers who use charts. Chart 1 is a good example of that. It's a monthly bar chart of the U.S. Dollar Index. [The USD trades the dollar against a basket of six foreign currencies. The euro and the yen are the most heavily weighted]. The Dollar Index peaked at the start of 2002 after forming a "head and shoulders" topping pattern for nearly a year (red circle). It fell sharply for the next three years. [A lot of money could have been made by shorting the dollar from 2002 to 2005 or buying foreign currencies]. At the start of 2005, the USD bounced off long-term chart support at 80 formed between 1991 and 1995 (green line). Since then the USD has been trading sideways in a potential bottoming formation (green circle). Chart 2 gives a closer look.
Chart 1
WEEKLY CHART LOOKS POSITIVE... The weekly bars in Chart 2 also show a market that is relatively easy to chart. After bouncing off long-term chart support at 80 (as it should have), it rallied right to chart resistance formed in the spring of 2005 near 92 (red line). At that point, the Dollar Index pulled back (also as it should have). The recent pullback has bounced off the rising (green) support line that started over a year ago. I'm watching those two converging trendlines very closely. A downside violation of the green line would be bearish. An upside violation of the red line would be bullish. At this point, the technical odds appear to favor the upside. Chart 3 gives an even closer look.
Chart 2
DOLLAR INDEX BOUNCES OFF 200-DAY AVERAGE ... The daily bars in Chart 3 (plotted through Thursday) show the improvement in the dollar's short-term trend. After backing off from its spring 2004 peak near 92 during November, it pulled back to its 200-day moving average. It slipped beneath that support line briefly during January, but quickly regained it. The USD bounced off that support line again in early March and is trading over its 50-day line. Notice how well the peaks and troughs in the Commodity Channel (CCI) Index have coincided with price peaks and troughs. Notice also that the daily MACD lines gave a short-term sell signal in mid-November and a buy signal in late January. This past week's dollar strength is primarily the result of the upside breakout in U.S. bond yields and helps explain the past week's commodity selling. Now for a way to actually trade the dollar.
Chart 3
RISING US DOLLAR PRO FUND ... A little over a year ago ProFunds launched two mutual funds based on the U.S. Dollar Index. One is tied to a rising dollar, and the other to a falling dollar. The next chart shows the Rising US Dollar ProFund (RDPIX). It looks similar to the USD in the previous chart. That's what it's supposed to do. The RDPIX is designed to trade in the same direction as the Dollar Index. So if you're a dollar bull, you can buy this fund and benefit from a strong greenback. If you're a dollar bear, you can buy the Falling US Dollar ProFund (FDPIX) shown in Chart 5. At the moment, chart trends favor the former.
Chart 4
Chart 5
BUYING THE DOLLAR FOR PROFIT OR A HEDGE... Why would you want to buy a dollar fund? One obvious answer is to benefit from dollar trends. A rising dollar fund will make money when the dollar rises. The other less obvious reason has to do with hedging. Americans who are invested in overseas markets stand to lose money if the dollar rises (and foreign currencies fall). If you're holding big overseas positions, you can hedge your foreign portfolio against currency losses by buying a rising dollar fund. That's only necessary if the dollar is rising. You can liquidate that hedge if the dollar starts to break down. For foreigners, it's just the opposite. They can buy a falling dollar fund to hedge their American bond and stocks holdings against currency loss. At the moment, that doesn't seem necessary.
