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Here are 2 Ways You Can Trade the US Dollar

By Costas Bocelli September 13, 2012 Facebook Logo Twitter Logo Email Logo LinkedIn Logo

Earlier this week, Chris Rowe shared his excellent analysis on the recent stock market rally to multi-year highs -- in particular, how it’s been affected by the move in the US dollar and the anticipation for further monetary easing signaled by the Federal Reserve.

And in one of my recent Tycoon Report articles a reader posted a comment asking if there’s any strategy that I could suggest to take advantage of a movement in the US dollar in either direction.

So I thought today would be a timely opportunity to continue the discussion on the US dollar and share two ways you can trade a move, whether you have a bullish or bearish outlook on the greenback.

Tracking the US dollar should be on every investor’s radar screen.  Your trading platform or favorite financial website where you get symbol quotations should offer access to the US Dollar Index.

As Chris pointed out, the US dollar has a significant impact across a host of global markets and securities.  It’s currently the world’s reserve currency and virtually anything traded, exchanged or benchmarked has some direct tie to its value.

The US Dollar Index is basically a measure of the value of the US dollar currency relative to a basket of foreign currencies.

And the US Dollar Index can be influenced by all sorts of catalysts, such as today’s FOMC monetary policy statement and Chairman Bernanke’s press conference that shortly follows.  One of the primary reasons that the dollar has fallen to a fresh 4-month low has been due to anticipation that the Fed is going to further ease financial conditions -- an action that’s dilutive to the value of the currency.

Aside from the monetary course of Fed policy, the US dollar can be reactive to other events.  The European debt crisis and the uncertainty surrounding fiscal policy can also greatly influence its direction.  Over the next few months, the US dollar must contend with who wins the White House, how Congress deals with the looming fiscal cliff, and any ramifications from a potential change in the credit rating.  Currently, both major rating agencies -- Moody’s and Standard & Poor’s -- have the US on negative credit watch for a potential downgrade.

In essence, the US dollar plays a ubiquitous role in most financial markets, and following its technical price action can only help you get a better grasp of the entire market landscape.

Below is a one-year daily chart of the US Dollar Index...

There are both bullish and bearish cases for where it goes from here.  To make sure you're prepared, here are two ways you could play either scenario...

Bearish on the US Dollar?  Get Bullish on Gold

As Chris alluded to earlier in the week, a falling US dollar usually puts rising upward pressure on commodity prices.  And with Central Bank policy remaining very accommodative for an “exceptionally” longer time, a weakening dollar is a boon for gold prices.

Gold had been consolidating for quite some time, and finally broke out to the upside in a big way recently. 

And when did that happen?  Around the time when the Fed released the FOMC minutes from their August meeting.  That’s also when the US Dollar Index broke a key support level (blue arrow on the US Dollar Index chart above, and on the GLD chart below).

So if you’re bearish on the US dollar and think this trend is only going to continue, consider getting bullish on Gold.  I prefer to get long bullish exposure to gold prices through the SPDR Gold Shares ETF (Sym: GLD).  You can trade directly in the ETF or trade options such as buying Call Contracts or Bull Call Spreads.

One-year daily chart on GLD...

Bullish on the US Dollar?  Get Bearish on the Euro

Do you think the slide in the US dollar is overdone?  If that’s your outlook, you could consider a bearish trade on the euro.

Why is that an appropriate strategy if you’re bullish on the US dollar?  It’s primarily because of the weighting in the index.  If you recall earlier, the US Dollar Index is comprised of a basket of foreign currencies.  However, in the basket, the euro currency represents roughly 60% of the weighting, essentially giving the euro a reliable inverse correlation to the direction of the dollar.

So while the US dollar just hit fresh 4-month lows yesterday, guess which currency just hit fresh 4-month highs?  That’s right, the Euro/USD currency pair.

So if you’re bullish on the US dollar and think it’s heading higher, you could take a bearish position in the euro.  I prefer to get bearish exposure through the Guggenheim Currency Shares ETF (Sym: FXE).  You can directly short the ETF or you can trade fully hedged option strategies like I do such as buying Put Contracts or bearish Put Spreads to profit from a potential decline in the euro ETF from a rising US dollar.

One-year daily chart on FXE...
 

The bottom line is that the price action on the US Dollar Index will be extremely important, and will most likely play a major role in the direction of many segments of the financial markets over the next few months.

And, based on your outlook for the US dollar, there are many ways to trade or take a position.

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