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Warning on the Dollar COT Report

Stocks in this article: UUP UDN

I believe a pricing pattern breakdown in the Dollar Index will lead to high probabilities of a sharp selloff. The commercials are not buying. That leaves it up to the speculators to continue to buy, and if they are already on the other side of the open interest, who is left to buy? This goes back to the probabilities of supply and demand and it is the reason why the commercial traders are "trend enders."

Think about what happens when the speculators want to sell and nobody else is buying? How do you unload that many contracts of your net long position without demolishing the price? When there are few bids to buy, and there are highly leveraged positions that have to exit "at the market"... that leads to a violent selloff if the bids are thin and the offers are large. Margin calls will exacerbate the supply side of the equation.

What could these commercials possibly know in the face of Euro disaster? Is this front running QE3 for a bailout of the Euro? Holding a leveraged long Dollar Index position while the market is closed with the current structure of this COT report would have me feeling like I was playing a game of Russian roulette.

I have no position in the dollar Index, and I am well prepared to speculate to the short side when there is an appropriate reversal pattern that develops. Although I believe this has great potential, trying to time the top is a good way to lose money.

Let's look at the chart below. Dollar is making new highs again but it is unable to close above the prior one. This is the second consecutive time it has happened, signaling a lack of demand at higher prices.

Keep in mind I do not rely heavily on technical indicators but it is worth pointing out the slight bearish negative divergence I marked with red trendlines on the MACD Oscillator and the RSI indicator.

Lastly the pattern on the dollar right now is a small "Inverted" or "Expanding Triangle" where the trendlines are diverging rather than converging as compared to the more common "Symmetrical Triangle." I have drawn this with blue trendlines. While the symmetrical triangle shows consolidation, the expanding or inverted triangle is showing confusion or congestion. This market over the past few days does not seem to be sure which way it wants to go.

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