By George Albert
The equity markets fell back to support and the dollar index rallied to resistance after a volatile week, but the question still is: will they break?
Support levels are price areas where the demand for an asset exceeds demand that generally leads to a rally in price. Resistance levels, on the other hand, are areas where supply exceeds demand that may result in a price drop. As we have said in our earlier articles, the dollar and equity markets are inversely correlated. Hence when the dollar rallies, the equity markets fall. The reason for this is simple. The US dollar is considered a safe haven and equities a risk play. Hence when the appetite for risk wanes, investors junk equities in favour of the dollar, leading to a fall in the former and a rally in the greenback.
Last week’s price action was interesting as both asset classes were brought to a crucial juncture. If the dollar index shows more strength and breaks out of its resistance level and equities display weakness to break below support, we could see a continuation of the trend.
In the previous week’s article we had mentioned that the Nifty looked weak and could break support which could take it lower. The break has still not happened and even though the index dropped, the Nifty will not go much lower, unless it closes below support. The index still looks weak as the support level has been hit multiple times; bulls planning to go long should stick to their stop-loss levels.
It is not just the Nifty that is at support. The Dow in the US also dropped to support last week, as the dollar index rallied to resistance. Let us take a look at the charts of Nifty, the Dow and the US dollar to get a clearer picture of the market. Let us first look at the Nifty (Click here for the Nifty chart).
Since 9 October, the Nifty has moved in the range of 5,725 and 5,635. On Friday the index fell as low as 5,641 before closing higher. This is clearly a range-bound market. Notice that the price has come down to the the 5,635 level multiple times, which is weakening the support at the 5,630 level. That support is shown by the blue horizontal line. We call it support as that is the level from where prices had rallied on 26 September, as shown by the blue arrow. It was also resistance earlier, which is shown by the red arrows. Former resistance levels often turn to support when prices rally above the resistance level.
Now if the price breaks below the 5,630 level, we could see the index fall to the 5,525 level, which is a huge gap. A look at last week’s article talks about this in more detail. However, if the index rallies and closes above 5,725, the Nifty could go higher.
Now let us take a look at the Dow Jones Industrial Average (click here for the Dow chart). Notice that the Dow is back at an area of support as shown by the two white horizontal lines. This is an area of support as prices had rallied from that level earlier and could do so again. However, if the index breaks that support level, which is around 12,975, the index could go lower. But so far the support has held for three days. In the case of the Nifty, however, the support level has been hit many times, thereby weakening it.
Now finally let’s take a look at the dollar index (Click here for the Dollar index chart). Notice that the resistance level has been hit multiple times. If the resistance is broken the index could rally much higher. A rally in the dollar index is a negative for the equity markets.
Normally, when the dollar is at resistance like now, it is a good time to short it. However, since the index has hit resistance a few times we’d be cautious about shorting. The same principle applies to the Nifty. Since it is at support, the normal thing to do would be going long. However, since the index has been hitting support a few times, we’d be cautious about going long.
But remember, unless the dollar closes above resistance and the Nifty below support, the break has not happened. So if you are an aggressive trader, you could go long on the Nifty with a stop below support and short the dollar with a stop above resistance. But if you are a conservative trader, you’d not initiate new positions unless the break happens. However, profit taking on existing positions would be good idea.
George Albert is Editor, www.capturetrends.com