Scott Pluschau is a Contributing Editor to the ETF Digest.Scott was a financial advisor with Citi. His technical analysis report on the Nasdaq Composite Index was recently featured by Dr. Marc Faber in his June 1, 2011 Gloom, Boom & Doom report. Scott earned his degree in Accounting and Taxation from Pace University. He lives in Long Island with his wife Ilona, daughter Olivia and new baby Henry.

Personally I own physical Silver for the preservation of wealth because I strongly believe in the long term downside fundamentals of the United States Dollar. I also own Silver mining companies as a wealth generator since I strongly believe in the long term fundamentals for Silver as well. Another common way to protect assets from dollar destruction is to diversify into other hard assets, the corporations that produce them, or the currencies of commodity exporting countries.

I have been tracking the Mexican Peso very closely because Mexico is the world’s largest producer of Silver. In full disclosure I do not have any position in the Mexican Peso at this time. Let’s take a look at some key developments on the weekly chart of the Mexican Peso exchange traded fund, symbol FXM, as of Friday September 16th, 2011 close, and compare it to what the Commercial Hedgers have been doing in the Mexican Peso Futures by looking at a few of the Commitments of Traders Reports at key points.

Back on the week of April 25th, 2011 when the Peso was making new 52 week highs, the Commercials were net short the Peso 138,648 contracts as of the April 26th, 2011 COT report. When the Peso was trying to make another push to new highs during the week of July 4th, 2011, the Commercials were net short 89,047 contracts on the July 5th, 2011 COT report. At first glance this might appear to be bullish, since the Commercials were not increasing their net short position. But looking at the Open Interest and not just the increase or decrease in the commercials net position tells the same story. On the COT report for April 26th, when the Peso made new highs the Open Interest was 170,977 contracts. In the July 5th report the Open Interest was 125,229 contracts. On a relative basis it was apparent that the Commercials were still of the strong belief that the Peso was overvalued near these highs.

On August 4th 2011, the Peso was breaking down below the low point in the valley where I drew a dashed trendline on the weekly chart, in what resembled a “Double Top” formation in technical analysis. Using “Swing Rule” the initial target for the potential move was the distance or length between the low point of the valley to the top of the formation, and that was nailed pretty quickly; in fact the gains were approximately 3x the initial target.

From an Auction Market Perspective this breakdown on August 4th, led to one sided price action, or vertical development seeking value at lower levels.

Looking at the COT report that came out on  Friday September 23, 2011,for the week ending September 20th, 2011, the Commercials are now net long the Peso by 19,346 contracts with the open interest standing at 76,010 contracts. This is a big move in the structure of the COT report since the Peso made new highs and is bouncing off the lows.  Could this mean the end of the selloff is imminent? I wouldn’t count on it. In trading, trying to time the exact bottom of a move has negative expectancy. What gives me an edge is finding a bullish pricing pattern in combination with an improving structure of the COT report.   I believe this type of trade setup taken again and again over time leads to positive expectancy of the trading system in the long run.

What pattern might I be looking for to better gauge my risk? The ideal situation in the auction would be for two sided price action to begin a new phase of Horizontal Development and form a mature balance area where the market temporarily seems to have found value. The initiative move then to the upside from the extremes of the mature balance area typically leads to vertical development and offers the greatest reward to risk in my experience. This type of price discovery seeking mission is known in the classic sense of technical analysis as a breakout from a “Rectangle” consolidation area on the chart and into a trend. Two way auctions go back and forth from Horizontal Development to Vertical Development, either finding value or seeking value in all markets and in all time frames. It is for that reason that I do not rely on the use of Oscillators, Elliot Wave, Gann Theory, or Fibonacci etc., in making any trading or investment decisions.

Perhaps the breakout from one of the other classic supply and demand technical analysis patterns such as a “Double Bottom”, “Inverted Head and Shoulders”, “Bullish Falling Wedge”, or “Symmetrical Triangle” will suffice instead. I would like to see a continuing improvement in the net long positions of the Commercials in respect to the open interest in the COT report at the time we have confirmation of a change in trend. That would be a no brainer trade for me, as long as I implement the correct position sizing and money management, since even with good enough probabilities and a favorable trade location, there is always the possibility for loss. No trade plan can prevent the unexpected.

Investing in the Mexican Peso may offer me another way to diversify US Dollars outside of the major currencies that are tied to the US Dollar Index, while still potentially capitalizing on the bullish long term fundamentals of Silver in the world’s largest producer of the metal itself. I see it as a double edge sword.