Tradable Scenarios for the British Pound
12 months ago forexsimulation 0
In the past couple of months, trading the pound has been all about brexit. In anticipation of the UK’s exit from the European Union, speculators have shorted the pound to historical lows, not seen for more than 30 years. Many short positions were taken in anticipation of a negative impact on the economy. But the UK stock index (FTSE 100) proved resilient to the vote in favor of exiting the EU and went on to climb above pre-referendum levels. This shift in terms of confidence regarding the future of the British economy acted also as a hand brake for the sharp fall of the pound. Coupled with encouraging economic numbers in the past weeks the British currency managed to pull a 5% retracement from the lows touched in July. Nevertheless, new concerns about Brexit talks coming up and the possibility of more monetary easing from the Bank of England has brought a new wave of uncertainty in the market. What is more, the FTSE is now climbing down from the highs and possibly heading towards a period of more sustained retracement. So in the light of these uncertain outcomes, much caution should be taken in trading the GBP/USD and focus on more short-term opportunities.
Below is a monthly chart of the pound showing its current level compared to the past 20 years.
Chart 1. Monthly overview of GBP/USD
Zooming in on the past couple of weeks, it seems as the pound is stabilizing within a channel between 1.2850 and 1.3400. It seems reasonable to trade in such a range as the current political and economic environment shows no clear fundamental direction. The question thus remains if we should short the high of the channel and buy the low, while waiting for a clear breakout to occur in any direction. As detailed in Chart 3. there is a clear bounce back from the upper band, sustained by increased volumes. The shooting star pattern that formed on the weekly chart is also a strong indication that 1.3400 acts as a resistance level.
Chart 2. Weekly overview of GBP/USD
Looking at the daily chart from the perspective of a possible breakout to the upside, we’ve spotted this descending trend line which has been broken to the upside, and now retested. If the line holds and if the market continues to make higher highs and higher lows, we might witness a rally above the 1.3400 level (the upper band of the channel) with a target set for the 38% Fibonacci level on the retracement from the 24th of June high of 1.5018. Also on a weekly level we have the prices above the 8 and 13 simple moving averages which provide some support to the bullish scenario.
Chart 3. Daily overview of GBP/USD
On the other hand, we should keep in mind that we are currently in a bearish environment and fishing the bottom is dangerous business. The current consolidation close to the lows might signal the preparation of another leg down. Close attention should be paid to price action and position building as the current breather in the market could act as a great opportunity for bears to load more shorts. Special attention should be paid to volumes: the distribution of volumes when prices rise and when they fall). If the market sentiment is still to the downside then we should see more volumes traded on bearish candles vs bullish ones.
As mentioned in the beginning of this article, trading GBP/USD should be done with caution, as the market is sensible to any news related to brexit negotiations or the economic health of the British nation. If you are looking to speculate on the possible outcomes from the scenarios described above, then you should consider limiting your risk with well thought stop-losses and avoid trading the breakouts above 1.3400 or below 1.2850 without genuine confirmations, both from a technical and a fundamental point of view. You can keep an eye on all the market developments and live currency rates in order to have an edge when the next move happens. Build your mindset around all the possibilities presented here and be ready to trade what the market gives you.
Firstly, there is this channel pattern that we are in, and until further technical and fundamental developments we should consider this consolidation valid. Thus, sell the higher band and buy the lower one. At this point in time, prices were rejected from the upper resistance and should head back towards the lows. The RSI (a momentum indicator) is still weak on a weekly and monthly level and a divergence (price making a new low, but the RSI staying above previous low) with a fake breakout to the lows could signal a bottoming of the prices.
The second scenario you should be prepared for is the one where the GBP/USD retraces towards the 38% Fibonacci level presented before, as the short covering continues, until new consistent announcements come out regarding the faith of the brexit negotiations. In this case, longs can be built around the current market levels (1.3200) as the trend line is retested, with the possibility to add more lots once the 1.3400 level is breached conclusively.
The last scenario, and the most solid one due to the current market conditions, is to short the pound as it slowly retraces towards the upper band of the channel. In case the 1.2850 level is broken, the market could go as low as 1.2000.
All in all, the pound offers great opportunities for a true speculator. The current market environment makes it sensible to any sentiment changes, which can in turn lead to more volatile price swings, both up and down. With the right mindset, good trades can be initiated in this market.