Keeping an eye on the dollar for stock direction
Author: Michael Arold
Covestor model: Technical Swing
Disclosure: Long WFC, LTD, DG, AIG, DFS
I took a passive stance to let the market consolidate its first-quarter gains, staying mostly in cash, and trading the Direxion Daily Small Cap Bear 3x Shares (TZA).
I expected a much stronger move to the downside, but stocks turned north during the last April week and prompted me to close my position.
On the upside, various stocks did set up nicely and offered great entry opportunities to go long. My favorite sectors turned out to be Financials and Consumer Discretionary. Therefore, I traded names like American International (AIG) , Discover Financial (DFS) , Wells Fargo (WFC), Limited Brands (LTD) and Dollar General (DG).
Many more stocks looked promising, but it was the beginning of earnings season, and I do not jump into positions right before companies report. There is no edge for individuals in trying to guess how companies will report versus expectations, the outlook, and how the markets will react. Overall, this usually limits the number of stocks I can trade during the beginning of earnings season.
Looking forward, I'm following various interesting developments, which should keep markets volatile. First of all, the greenback is in key position to trigger major moves in other markets. The US Dollar Index has been moving lower in recent weeks and is about to reverse its intermediate term uptrend. The currency recently broke down out of a symmetrical triangle pattern after moving sideways for several weeks. A weak dollar would be bullish for stocks and certain commodities. One of the asset classes to reap the benefits is likely gold, which is the second notable development. The metal went through an extensive consolidation phase during the last six months and could be ready for another leg up (see related Covestor post).
Gold is trading with strong support around $1600, so a long trade with a intermediate term target of $1900 results in a compelling risk/reward ratio when entered at current price levels. The market expectation is for additional quantitative easing measures, which could push the dollar and U.S. Treasuries lower, and gold higher. I plan to ride it by trading stocks and/or ETFs in the Basic Materials and Commodity sectors.
Coal stocks look particularly compelling after some of them lost over 70% of value over the last year. Bottom fishing is dangerous, though, which is why I'm using technical tools before making trading decisions. Walter Energy (WLT) is an example of a coal stock that has been finding buyers in recent months and is on my watch list.
Spain and the overall situation in Europe are wild cards and the third interesting development I am monitoring. The Spanish stock market kept underperforming in April and offered a nice entry opportunity in April to hedge my US-equity long trades after a brief short-covering rally.
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