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Dollar Index to Rally on Euro Weakness: Charts

Tuesday, 3 Jan 2012 | 7:39 PM ET

The crisis in the euro zone continues to get worse. The euro has fallen to support near $1.29. A fall below this support level has a new support target near $1.24. The weakness in the euro is counterbalanced by increasing strength in the U.S. dollar index. Analysis of the index suggests a significant increase in the dollar index, and in turn, a significant fall in the euro.

The dollar index chart is dominated by several features and they are best seen on the weekly chart, which is dominated by fast rallies and retreats between well established support and resistance levels.

The most important support level is at 74.5. There are three resistance levels. The first resistance level is near 79.5. This is the lower edge of a narrow consolidation band. The second resistance level is near 81.5. The dollar index is currently trading inside this narrow consolidation band. Further weakness in the euro will lift the dollar index above 81.5.

This consolidation band is important because when the dollar index breaks above 81.5, the third resistance level is near 88.5. Historically there aren't any strong resistance levels between 81.5 and 88.5. This may develop a very fast parabolic trend similar to the trend in 2010 May. This potential for a very fast rise has significant consequences for other currencies.

A fast up-move in the dollar index above 81.5 suggests increased weakness in the euro-dollar with the potential for the euro to fall below support near $1.24. This may test the historical lows of US$1.19 for the euro in June 2010.

Strength in the dollar index is also bearish for gold. Gold has support near $1550. Lower support is near $1450. Normally these targets would be achieved because of the increase in strength in the dollar index.

However, in the current situation, the weakness of the euro is the main reason for dollar index strength. Traders may also decide to shift into gold as a hedge against euro weakness and this will counterbalance the extreme bearish pressure in gold. The exact impact on the gold trend is confused because of these two different pressures.

The most important feature of the dollar index chart is the development of very fast rallies and very fast retreats. This is a rally and retreat environment. It is not a trending environment. Investors can anticipate continued volatility with rapid up and down moves in the U.S. dollar.

Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com . He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.

If you would like Daryl to chart a specific stock, commodity or currency, please write to us at ChartingAsia@cnbc.com. We welcome all questions, comments and requests.

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