The US dollar has been on a wild ride since the Non-farm payrolls jobs report, with the US dollar dropping in the aftermath of the report and then rallying back sharply after the Independence Day holiday.
The technical backdrop for the US dollar index is warning that a major breakout is looming, as a head shoulders pattern hints that the US dollar is either going to explode higher or fall to multi-year lows.
It is clear that once traders and investors make their minds up about which direction they are taking the US dollar then a powerful new weekly and monthly trend is likely to take hold.
Summer months can often paint a confusing picture as the trading action often seem counter intuitive, especially the bond and the foreign exchange market. The US dollar rose after the weaker-than-expected ISM Service report while bond market rallied sharply.
When economic data points come in below expectation it usually means that the surrounding currency will fall. This would also seem more probable for the US dollar as expectations of the FED scaling back QE is likely to increase. This is also why current moves in the market feel somewhat confusing.
The ActivTrader market sentiment tool is showing that bearish sentiment has increased dramatically this week. Negative sentiment has picked up to 81 percent, which is a solid increase from 68 percent just one-week earlier.
Heavy sentiment skews are often wrong, however, it should be noted that the trend is current bullish for the US dollar, as the index trades around 100 points above its 200-day moving average. The one-way sentiment bias is a concern right now, however, retail traders are running counter trend, so more gains are certainly possible.
US Dollar Index short-term Technical Analysis
Looking at the four-hour time frame a head and shoulders pattern is looming over the US dollar index, with bulls needing to move the price above the 92.90 level to invalidate the pattern.
According to technical analysis the pattern will be activated to the downside if the price moves under the 92.00 support zone. Watch out for a potential 75 point move once the 92.00 to 92.90 price range is broken.
US Dollar Index Medium-term Technical Analysis
According to the daily time frame, a much-larger head and shoulders pattern remains the central focus for traders over the medium-term horizon. Whether the pattern survives or is invalidated this week is likely to determine the next 300 points move in the US dollar index.
If bulls can break the 93.40 resistance level then the US dollar index could surge towards the 96.40 area, however, if the pattern is not invalidated then we could see a sudden pullback towards the 91.40 area, at a minimum.