I’ve been focusing on the dollar because it’s been an excellent guide to equities’ behavior.  There’s been a lot of talk lately about the correlation between the two shifting from highly negative to positive.

The fact is, the dollar didn’t suddenly change it’s stripes.  It has simply rallied in anticipation of a market correction that, as yet, hasn’t yet gathered much momentum.

This has happened many times over the years, as the chart below demonstrates.  Most of the DX spikes correlate with actual market corrections.  The others correlate with expected corrections.

Note the times when DX spiked toward the white channel midlines.  The actual SPX plunges with which they match up include 741, 666, 1010, 1074, 1266 and 1343.  The other DX peaks match up with the expected SPX corrections listed below:

• .618 Fib:   the retracement of the crash from 1552 to 768 (2000 – 2002.)
• 1173:  the .786 retracement of the 1576 to 666 crash (2007 – 2009)
• 1308:  the .786 retracement of the 1370 to 1074 correction (May – Oct 2011)

The same could be said the the DX plunges.  The 1576 peak from 2007 was a bit of a surprise from a chart pattern and Harmonic standpoint.  But, the 184-pt rally from Mar – May 2008 was seen as a top in the works – especially coming near the .618 of the drop from 1576.

The .500 Fib refers to the retracement of the 1576 to 666 plunge – a logical place for a pullback after the 450 points gained in only 8 months.

The .618 Fib refers to the actual retracement of the 1576 to 666 crash.  The previous pullback in April came in just a bit shy of the actual Fib level.

1370 was obviously an important high in 2011, as was 1292: the ramp job that derailed the 2011 as 2007 analog.  1474 was the Sep 2012 high.  And, the low marked Point C was where the two large Crab Patterns should have caused a reversal at SPX 1553-1555.

So, what about our present position?  DX just tagged the smaller channel’s midline, so clearly currency traders have anticipated a correction.  Since we haven’t had much of one yet, it’s possible DX could be sending a false signal.

On the other hand, the larger channel midline is only 1.81 away — a mere 2.2% away.  And, the rising red channel is guiding us straight towards it.  About 2/3 of the daily candles since Mar 12 have crossed over a trend line between the last two important tops: Jun 9, 2010 and Jul 24, 2012.

So, clearly the dollar is having trouble making up its mind whether or not to break out.  It bounced off the bottom of the purple channel and the .25 line of the red channel on Tuesday, rallied strongly on Wednesday, and ended the day right on the TL.

Want to know where stocks are going?  Watch to see what DX does.  It knows…just isn’t saying — yet.

 

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The dollar backtested an important channel line Tuesday (red, below) and bounced up through an equally important trend line (dashed, yellow).  If it holds, equities are in for more downside.

We turned bearish on April 11 [The Big Picture – 11:30 update], shorting at SPX 1597 due to a collision there with two long-term trend lines.  Since then, the channel that has guided SPX up from 1343 has been holding on for dear life.

It finally broke down yesterday morning when SPX plunged below 1556.60 on its way to 1543, and we’re waiting to confirm whether or not the initial backtest is complete.

Remember that 1540 is the Apr 5 low and the neckline of the potential H&S Pattern I charted on the 16th.  We should get a bounce that retests the broken channel and either keeps going or completes the H&S Pattern, setting up the next leg lower.

UPDATE:  10:15 AM

We reached 1541.05 —  close enough for those interested in playing the bounce.  I’ll try a long position here, but revert back with any move through 1540.

More in a few…

UPDATE:  10:30 AM

Getting some air here, helping the H&S case. The left shoulder was way up at 1573, which would be about a 61.8% retracement (1575.84) of the drop from 1597 to 1541.  It would also represent a second retest of the 1576 high from 2007.

The more nefarious aspect of a move to 1576 is that it would set up a potential Inverted Head & Shoulder Pattern targeting 1611ish.

Bears aren’t out of the woods yet.  As we’ve discussed, at this point the bulls can legitimately argue that the drop to 1541 was a backtest of the broken red 1.618 at 1553.39.  Recall, this represents the completion of the Crab Pattern set up by the drop from 1370 to 1074 in 2011.

SPX closed at 1552.01 yesterday — slightly below the 1553.39 line in the sand.  So, this would be a slight violation of the rules (so are gifting $85 billion to the banks every month, all the ramp jobs over the past several months, etc;  we’ll not quibble over a point or two.)

If SPX can close back above 1553, we’d have two bullish candles in a row and a good shot at tacking on the necessary points.  So, we’ll keep this scenario in the back of our minds.

UPDATE:  2:20 PM

There’s the actual 1540 tag we discussed earlier.  The previous low was 1539.50, so we’ll see how SPX reacts at that level specifically.  I’m ready to cut and run if it pushes lower.

Not saying it will rally from here, but we had a very similar incident back in April 2012.  SPX “completed” a right shoulder in a pattern that looked very solid — but had in reality just missed on the right shoulder’s first tag — only a couple of points, not enough for most to notice.

Because the right shoulder wasn’t technically complete, though, it wasn’t really a right shoulder.  SPX bounced 58 points and completed a proper RS before finally playing out and touching off a 100-pt decline.  So, be careful and watch your stops.

UPDATE:  2:53 PM

SPX just pushed through our stop at 1540, so we’re done with the long position and reverting back to full short.

Just beware that the right armpit is allowed to be lower than the left — since the inception of the pattern is adjustable.  That is, the neckline can be sloped downward as long as the two armpits connect and the shoulders are complete.

Not a bad idea to have stops up around 1541 just in case — especially as we move into the final hour of trading.

UPDATE:  3:08 PM

This is what I meant by the last comment up above.  No reason the red, dashed line couldn‘t be the neckline.  Is it legit?  Yes.  Is it cricket?  Not even close.  Do paranoid people ask themselves lots of rhetorical questions?  Apparently.

I’m going to add an intra-day long position if we push up through 1540 — just in case.  Don’t trust this move one bit…

Coming up, a look ahead.

continued for members…

As suspected, we got a push back up through 1540.  I’ll add an intra-day long position to go with my existing short.  Stops for the long should be around 1538ish.

UPDATE:  3:40 PM

Here’s the problem that bears face: a breakout on the 60-min RSI.  Though only a short-term indicator for now, it means SPX needs to close back under 1540.  If it doesn’t, I probably need to think about closing my short position.

Either way, it’ll probably come down to the last couple of minutes.  As usual.

UPDATE:  3:57 PM

Hate to do it, but I’ll close my short here and let the long position ride.  Need to make some calls; I’ll be back in 30-45 minutes or so.