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British Pound Plummets to Lows, but is it Too Much Too Soon?

By , Quantitative Strategist
09 July 2013 17:00 GMT

The British pound has fallen to its lowest levels since 2010 as professional traders pile into short positions and disappointing economic data worsens GBP malaise. But we’re seeing evidence that the rally might be too much too soon, and indeed there’s material risk of a short-term bounce.

The British Pound has fallen about 5 percent in the past 3 weeks (15 trading days)—matching its worst decline since it hit multi-year lows in September, 2011. Indeed, the chart below shows that this 3-week Rate of Change has coincided with fairly important GBPUSD lows on many occasions.

British Pound Tumbles to Fresh Multi-Year Low Versus US Dollar

forex_british_pound_too_much_too_soon_body_Picture_5.png, British Pound Plummets to Lows, but is it Too Much Too Soon?

Source: FXCM Trading Station Desktop, Prepared by David Rodriguez

We likewise see evidence of extremely one-sided forex retail crowd sentiment as another sign of a potential GBPUSD low. Our proprietary FXCM Speculative Sentiment Index data measures retail forex trading sentiment via actual open trades. We most often use it to go against the crowd—if everyone’s buying, we typically want to sell and vice versa.

The SSI shows crowds have been long GBPUSD since it dropped below below $1.54 on June 26, which gave signal the British Pound might fall further.

Indeed, our sentiment-based Momentum2 system went short GBPUSD from $1.5377 and again from $1.5101. At the time we said that the US Dollar stood to rally further against the British Pound (GBPUSD decline) and others, and in fact Momentum2 was our favored GBPUSD trading strategy.

Since then however, forex trading crowds have bought so aggressively that we think it might be too much too soon. The total number of retail open orders long British Pound is at its highest since the GBPUSD set a major low in March of this year.

Retail Forex Traders Extremely Long the British Pound versus the US Dollar

forex_british_pound_too_much_too_soon_body_Picture_6.png, British Pound Plummets to Lows, but is it Too Much Too Soon?

Source: FXCM Speculative Sentiment Index, watch a video on the SSI

What does this all mean? In our opinion we could see a potentially significant GBPUSD low set in the next several days. Indeed our Senior Market Strategist Kristian Kerr thinks one-sided sentiment and cycle studies point to a larger US Dollar turnaround this week.

Kristian likewise points out that a major bank trading platform reports volume 3 times its recent range on the GBPUSD. Professional traders are usually on the correct side of the trade as they sell into downtrends and buy into uptrends.

But history shows that the pros are the most bullish at the top and bearish at the bottom; the big build in professional long positions warns we’re near a short-term turn. This is literally the opposite we see with our retail trader-based SSI data and helps confirm our SSI-based evidence.

Does this mean we’re looking to go long the GBPUSD today? Not exactly. I wrote on Monday that it’s quite possible the US Dollar gives back some of its recent gains, but I’ll actually look to a USD sell-off (GBPUSD bounce) as an opportunity to buy the dip (sell GBPUSD strength).

Our Senior Technical Strategist favors looking for an important near-term GBPUSD top near $1.50 or $1.51. And indeed, if the GBPUSD approaches key resistance it may represent an attractive selling opportunity.

--- Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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09 July 2013 17:00 GMT