The world markets were in for a massive surprise on June 23, 2016, when the UK voted to leave the European Union (EU). All risky assets sold off hard and the safe havens witnessed a strong rally. The pound was the worst hit, dropping to levels not seen since 1985, which underlines the significance of the event.
Nevertheless, it was not the worst one-day fall for the pound. The pound has survived a 30% drop during the 70s crisis. It again fell by a quarter when Britain exited the Exchange Rate Mechanism in 1992.
The pound is the oldest currency in the world and has been around for more than a thousand years, which is a proof of its resilience. Hence, one thing is certain that the UK will not be wiped out from the face of the earth just because it has left the EU. Neither will it plunge into an extreme recession because of the Brexit.
As this is the first instance of a nation breaking away from the EU, no one really knows how things will pan out; however, we can get an idea by analyzing what we do know…
UK will lose its biggest market, the EU
The member nations in the EU get free access to all the markets of the union. Imports and exports don’t carry any charges. “More than 50 percent of our exports go to EU countries,” reports Sky News.
“The EU is currently negotiating with the US to create the world’s biggest free trade area,” says the BBC, “something that will be highly beneficial to British business,” reports The Week. The UK will miss out on all such successful pacts.
In the short-term, the EU will most probably introduce certain charges to access its markets, which will increase the cost of the UK companies and hurt their profitability. Nevertheless, as the new relationship between the EU and the UK evolves, restrictions will ease out and new agreements will be formed.
Investments will suffer in the short-term
Various reports suggest that investors pulled out close to $100 billion in investments leading to the Brexit vote. When there is uncertainty about the future, companies scale back their plans until clarity emerges.
Though the EU leaders have asked the UK to quickly start the exit process, negotiations are likely to pull along for 2 years. During such a time, it is likely that there will be a considerable slowdown in investments.
However, once a clear picture emerges, investments will slowly start trickling in. In other words, there will be a rebound, we just need to worry about timing.
Many media outlets are crushing the UK…
Saying that companies will bail on London and move to other hot spots in the Euro Zone like Luxemburg so that they don’t lose access to the whole EU market.
They may be right, but are probably over-stating it. Either way, it doesn’t really matter.
The UK has the opportunity to refresh and reinvent itself. Just look at Singapore and the MASSIVE amount of inflowing cash they are getting—without being attached to the EU, of course.
I believe the UK remains, by comparison, one of the most stable nations we have. And where there is stability, MONEY COMES IN.
For me, this is a reason to have a lot of confidence in a longer term rebound for the UK and its assets.
There is a large difference of opinion among the economists on whether the UK will face a recession or avoid one. While Goldman Sachs believes that the UK will enter a recession early next year, Moody’s believes that the UK will grow by 1.5% in 2016 and 1% next year.
To be honest, I don’t care much about what they say. Whether right or wrong, it’s not really my goal—as a trader—to determine if the UK will grow by a few ticks more or a few ticks less.
I think most of that forecasting is over-valued.
In 2007, Alan Greenspan was saying that the US Housing Market was as strong and stable as ever before the biggest housing crash in a generation. It just goes to show that the talking heads should not be your investment guide.
Instead, let’s focus on the real opportunities within the market and how we can trade them.
How to trade the Pound in the aftermath of the Brexit
Long-term monthly charts
On the long-term charts, the GBP/USD pair is negative, as it has broken down below critical support levels. The next target on the pair is around 1.23 levels. However, on the previous occasions, whenever the pair entered oversold levels on the RSI, it gave a strong bounce (marked on the chart).
I expect a rebound will also occur this year.
Before buying up Pounds (though I fine with buying small amounts and building a position with low leverage), let’s try to find confirmation of exhaustion and “pick our spot”
The weekly chart shows that the pair is falling in a channel. The price has touched the lower end of the channel. Technically, unless the lows get violated, the pair should try and correct upwards towards the higher end of the channel to 1.43. The RSI is showing a positive divergence, which is also a bullish sign.
Let’s see if the Daily Charts show us anything different.
The GBP seems to want to rebound here and the Daily is holding with some stubbornness.
I think a long to 1.3500 is a good trade.
If it fills the gap there, the next move will likely be the best indication of where we’ll be heading for most of Q3 2016. If we retest the 1.3500 area and show continuation back to the downside, it’s likely that it will move all the way to new lows.
For me, that’s even more of a buying opportunity as I believe the GBP is simply worth more than 1.2500 to the USD.
To summarize, my trading plan is a near term buy and exit. Then a waiting game with a potential longer term buy to follow if prices continue to fall.
So what about the EUR/GBP?
EUR/GBP Weekly chart
The pair has broken out of the two downtrend lines drawn on the chart, albeit only marginally. The next logical target on the upside is 0.8821, however, as seen on the charts, the EUR/GBP pair is currently in an uptrend within the channel, as shown below.
The price is touching the upper end of the channel and the RSI is also about to enter the overbought territory.
Unless the pair breaks above the channel with momentum I think we are in a similar situation (though opposite direction, of course, as GBP is the quote currency here) as GBP/USD with a near term short position in play.
If we see a move back to the bottom of the channel and more Bulls coming in to support it, we can easily jump right over the long side and ty to ride it back toward .8500
However, if the price moves down with more pace than most are expecting and breaks (Bearish) through the bottom of the channel, it’s a massive reversal signal with well over 1,000 pips to the downside.
The Daily chart shows a better picture of how over-extended the market is here and even though we may not see a drop all the way to .7600 I would be surprised if we didn’t get some settling.
Every adversity also offers an opportunity to the smart investor and I see a few opportunities to profit by trading the GBP/USD and the EUR/GBP pairs as shown above.
I am in confident in the GBP’s ability to rebound, but keep in mind that we are very early in a long, chaotic process and the market is likely to be pretty volatile for a while. Still, sometimes volatility is the best thing for a trader’s bottom line.