The British Pound took a pounding after the surprising vote to leave the European Union, but has since stayed above US$1.30 for the second half of July. Short-term traders with limited risk needn't try and predict whether this is the bottom.
By Vikram Rangala
Monday, August 1, 2016
There is a slight, two-week-long trend to the upside in the price chart of the GBP/USD exchange rate. This is leading many investors and analysts to conclude that the post-Brexit meltdown has passed and some of the fear of the unknown may have dissipated.
Once we get past the question, "What will the UK be if it's not part of the EU?" we get to the current question, which has to do with what exactly the UK is right now. What is its manufacturing strength, how is its employment and credit situation, and how effective is the new government of Prime Minister Theresa May? These are long-term questions and it's fitting that long-term investors and economists should look at them.
In the short-term, the currency of the nation that gave us Shakespeare and Downton Abbey has been appropriately dramatic. The day after the EU referendum, sterling dropped roughly eight percent versus the USD. The one day drop was followed by a couple more slides, but no further big drops.
Instead, the pound appears to be treading water above $1.30 and has yet to retest the $1.29 low from July 6. Of course, as anyone knows who has seen a movie with a character treading water and starting to feel calm after having gone underwater once before, there is usually more drama to come. As The Economist said on July 9 and continues to repeat, "It would be no surprise if the pound continued to slide."
Investors took moves that signal they expect the Bank of England to loosen monetary policy, selling sterling assets in cash, derivative, and other forms. The BOE has already reduced capital requirements for banks to increase lending capacity. It is expected to make its first cut to the base rate since 2009 this week, from the current all-time low of 0.5% to 0.25%.
While the pound has weakened versus the dollar, it maintains some strength against the larger basket of major world currencies. The euro also took a beating after the Brexit referendum. In a sense, the currency markets didn't see it as a victory for either side of that vote, though perhaps traders inadvertently cast a vote for the US dollar.
The glass-half-full way to look at that is, the pound is still not so badly off. The half-empty view is that the pound has further to fall. Historically, it has been lower. It spent more than two years under $1.30 before taking off in 2002 for what turned into a five-year bull run in which it gained roughly 66%, before crashing during the financial crisis.
Long-term investors who see this as similar to 2002 are positioning themselves to buy and hold for another long rally. But in the short-term, the market will have a lot of volatility and most likely some more big drops. Long-term investors with deep pockets will generally just ride out these drops and even add to their positions as prices get cheaper. Those investing in securities or derivatives that reflect the value of the pound are preparing to spend the next year or more taking hits and picking up bargains with an eye on the long game, which ends after 2020.
But there is opportunity in the short-term as well, for traders who can take advantage of the swings. Traditional swing and day trading, especially in currency futures or forex pairs, requires using stop-loss orders that not only don't guarantee risk control (because of slippage) but also can take you out of a trade only to see the market turn around and prove you right. It's the worst of all worlds for a trader. Options can limit your maximum loss, but have their own limitations.
Many traders, including long-term investors, have opinions about this Thursday's BOE decision and how the market will react to it. But most investors won't trade that opinion. They'll just ride out any drops that might happen or rejoice at a temporary spike only to see the GBP/USD drop back to where it was on Wednesday. Some traders may take positions in currency futures or forex, but get stopped out by a volatile move and find themselves sitting on the sidelines with a loss, watching the markets do exactly what they predicted.
Exchange-traded binary options (ETBOs) on Nadex offer a different trading experience. First of all, they guarantee limited risk. Second, they are based on a simple question: will the GBP/USD (or EUR/USD or EUR/GBP or FTSE 100 stock index) be above this price at this time? Yes or no?
By reducing trading to simple question about a specific window of time, they make the decision more straightforward. If you see a downtrend immediately after the BOE announcement, you can trade just that move, even though you know it will probably flip back up by afternoon. In fact, you could trade both the moves. Short-selling with binary options is no more difficult than going long.
One reason ETBOs or binary options on Nadex have been called the future of trading is the mindset. You can have one opinion about the long-term strength of say, the UK economy and the British pound, but have a separate take on what a market is going to do this week, or today, or even in the next hour. The two really have nothing to do with each other. You can be bullish about the pound but sure that it's going to take a huge hit later this week. Or you could have the opposite opinion, that it will see a flurry of buying and then sink through the end of the year.
Use your long-term investment portfolio to take positions on your long-term views. But with Nadex, you now have a limited-risk, versatile way to turn your short-term decisions into trades without the limitations day traders traditionally have had to put up with.
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