The Canadian dollar has been having a short covering rally for the past few months, gaining nearly .1000 relative to the U.S. dollar. However, the major trend remains down as this market continues to put in lower highs and lower lows.
The Canadian dollar was at par with the U.S. dollar in February 2013. For the past three years the loonie has trended lower, getting down to .6800 in January 2016. A two-week reversal developed on January 22, 2016 which indicated the Canadian dollar was about to turn up. Today it is closer to .7800.
A two-week reversal develops when on the first week, at a low, the market advances to new lows and closes very weak, at or near the low of the day. The following week, prices open unchanged to slightly lower, but cannot make additional downside progress.
Quantity buying appears early in the week to halt the decline and prices begin to move higher. By week’s end, the market rallies to around the preceding week’s high and closes at or near that level.
The two-week reversal is a 180-degree turn in sentiment. On the first week the shorts are comfortable and confident. The market’s performance provides encouragement and reinforces the expectation of greater profits. The second week’s activity is psychologically damaging. It is a complete turnaround from the preceding week and serves to destroy or at least shake the confidence of many who are still short the market. The immediate outlook for prices is abruptly put in question.
Shorts respond to weakening prices by exiting the market. At first the shorts exit to protect profits and then to cut losses. This is commonly referred to as a short covering rally and is confirmed by declining open interest in a rising market.
Just as chart analysis is useful for determining a change in price direction, it can also be used to determine the price trend. Prices over a period of several months or years are generally either moving up or down. This direction is the long-term or major trend of the market.
Within the major trend there are a series of prominent peaks and valleys that can be of several weeks’ duration, which create the intermediate trends. Finally, there are small fluctuations within the intermediate moves that are the minor trends. Therefore, a trend may be interpreted in varying ways, but our focus here is on the intermediate and long-term perspectives.
During the course of a trend and all the fluctuations which compose it, there is a well-observed characteristic for prices to closely follow a sloping straight line path. During a period of rising prices, this path is determined by a line drawn across the lows of the reactions, which is illustrated as (A) in the accompanying chart.
In a rising market, for a trendline to be both valid and reliable there should be at least three points of price contact, each of which coincides with the low of a market reaction. These price reactions must bottom at progressively higher levels.
Thus, a properly constructed trendline may be touched several times by the fluctuating market during the course of a move without being penetrated. The longer the trendline endures, the more significant becomes its eventual penetration as an indicator of trend change.
Producers who recognized the two-week reversal and patiently waited to convert the Canadian dollar to U.S. currency, have been rewarded for doing so.
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