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Down Goes the Dollar, Down Goes Gold

With the U.S. dollar back on the edge of oversold, a near-term bounce may be a trader's best bet

by 4/18/2012 9:05:56 AM
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Heading into trading today, there are no major exchange-traded funds (ETFs) in technically oversold territory. This is a testament, in part, to the strength of Tuesday's rally, which sent the Dow industrials higher by more than 200 points intraday and the Nasdaq higher by more than 50 points. Markets that had been languishing in or near oversold territory in the days leading up to Tuesday's big bounce made some of the biggest moves. The State Street Technology Select Sector SPDR (XLK) gained more than 2% after a two-day pullback and oversold close on Monday. Up more than 1.5% on Tuesday after spending two days in technically oversold territory was the iShares Nasdaq Biotechnology Index Fund ETF (IBB).

So where does a trader have to go to find a pullback in this market? Trading lower for a second day in a row on Tuesday, the PowerShares DB US Dollar Index Bullish Fund (UUP) is not yet technically oversold. But of all the ETFs in our database that are trading in bull-market territory, UUP and its two-day retreat are perhaps the most worthy of watching.

There is a strong argument that UUP has been in pullback mode since a short-term top in overbought territory on April 5. UUP has closed lower for five out of the seven sessions since then, though only finishing oversold once (last Thursday). However, should sellers continue to press their offensive today, it is very likely that UUP will return to oversold levels where traders, historically and in the short term, have been more inclined to buy than sell.

An example of this kind of reaction to oversold extremes in UUP is as recent as late March. A steep drop in the ETF, which ended with four consecutive lower closes -- two in technically oversold territory -- led to a bounce that sent shares of UUP higher by more than 1.5% over the next three days.

One thing that is especially interesting about the selling in UUP is that it comes at the same time that traders are moving out of gold, as well -- at least, in the short term. Not among the higher-probability trading opportunities to the long side, based on its location below its 200-day moving average, is the gold bullion tracking ETF, the SPDR Gold Trust (GLD). Nevertheless, it has pulled back for three days in a row and is technically oversold -- again, albeit in bear-market territory. GLD edged lower on Tuesday, but managed to end trading well off session lows.

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David Penn is Editor in Chief of TradingMarkets.com

Disclaimer: The views represented in this column are those of the individual authors only, and do not necessarily represent the views of Schaeffer's Investment Research.

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