Dec. 10 — The Canadian dollar was supposed to go par. At least this was the hype when the market peaked at US97.98 cents on Oct. 15. When a commodity makes the headlines of major newspapers and magazines, it is often a tell-tale sign that it is near the end of the rally. When most consumers know that a market is supposed do something, the smart money begins to look for reasons to look the other way.
At Ag-Chieve, we turn to the charts to help us cut through the news, or the noise, as I refer to it. Farmers who understand that the news is the most bullish at the top, and who identified the two-day reversal in the accompanying chart, were able to convert Canadian currency to U.S. dollars before the opportunity disappeared.
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(Editor’s note: Readers viewing this article on AGCanada.com can click here for a version with the chart attached.)
Two-day reversal
The two-day reversal indicates a change in price direction. On the first day (at a high for the move) the market advances and closes near the high of the day. Prices open unchanged to slightly higher the following day, but fail to make additional upside progress. The advance stalls and prices begin to erode, as selling picks up early in the day. By the end of the day, the market drops to around the preceding day’s lows and closes at or near that level.
Follow-through weakness the following day helps to confirm the pattern’s validity. This two-day reversal indicates the recent rally has run out of steam and prices are about to turn down.
Market psychology: The two-day reversal signifies a turn in sentiment. On the first day, the longs are comfortable and confident. The market’s performance provides encouragement and reinforces the expectation of greater profits.
The second day’s activity is psychologically damaging. It is a complete turnaround from the preceding day and serves to shake the confidence of those who are long the market. The immediate outlook for prices is abruptly put in question. Longs respond to weakening prices by selling in order to exit the market. Some longs sell to take profit and others sell to limit losses.
Lines of support
During the course of a trend and all the fluctuations which compose it, there’s a tendency for prices to follow a sloping or horizontal straight line path.
A line of support is determined by drawing a line across the lows. For a trendline to be both valid and reliable there should be at least three points of price contact — illustrated as A, B and C in the accompanying chart. Each point coincides with the low of a market reaction.
A trendline may be challenged several times by the fluctuating market without being penetrated. The longer a trendline remains intact, the more significant the eventual penetration becomes as an indicator of trend change. However, a price violation of the line is not enough bases to conclude that the trend has turned. At the very least, a market must close decisively beyond the line.
Market psychology: Support areas materialize, as a market attracts buying down at the line of support. When prices break down through the line of support, then all recent buyers end up holding losing positions. Consequently, the offering of contracts for sale increases as longs liquidate and shorts who sold at higher levels add to their profitable positions.
This analysis indicates the Canadian dollar may not reach par. A close below US92 and then 90 cents would confirm the eight-month rally is over and prices could slip to US86 cents. A rebound in the U.S. dollar and a downturn in the crude oil market would weigh on the loonie.
