Trading GBP/USD: An Overview of the Pound-Dollar Forex Pair
In recent times, the institutional Forex market has become the largest financial market in the world. There are also a growing number of retail Forex traders. And when it comes to Forex, GBP/USD looms large. GBP/USD is the third most traded forex pair in the world and accounts for just under 10% of global foreign exchange turnover. In the most up-to-date report from the Bank for International Settlements (BIS), GBP/USD also known as “cable” accounts for 9.6% of the volume.
GBP/USD is among the most liquid currency pairs to trade in FX, which can suit traders on shorter time horizons. High liquidity means that spreads are tight, while transaction costs are minimal. Many trading strategists believe it is important to stick to highly liquid currencies—such as pound to dollar--to grasp an understanding of forex trading. It can be easier to learn forex trading with highly liquid currencies before moving to illiquid currency pairs—often targeted by very experienced traders.
This page on pound to dollar forex trading has five sections, each one designed to help the reader understand key concepts. Terminology highlights terms often used in Forex trading. The Importance of the US Dollar talks about the role of the American currency in FX. Best Time toTrade touches on some of the most active periods of liquidity and volatility. Market Structure covers key participants in Forex and GBP/USD including central banks and hedge funds. Tips for Fundamental, Technical and Advanced trading addresses macroeconomic events GBP/USD Forex traders watch, charting techniques and correlation analysis.
If you are a long, you want to own that asset on the expectation that it will rise in value, while if you are short, you sell something that you do not own, betting that the price will fall. In FX markets, you are simultaneously long and short a currency when taking a position. For example, if you are long or buying GBP/USD, you are expecting the Pound to rise in value against the US Dollar and vice versa.
Understanding the Importance of the US Dollar
When trading GBP/USD is it also important to understand the US Dollar, particularly when the dollar accounts for 88% of all trades in FX. In the early 2000s, an FX strategist from Morgan Stanley had invented the “dollar smile” theory, whereby the US Dollar tends to strengthen when the US is very strong or very weak, while relative growth outperformance in the rest of the world compared to the US leads to a weaker dollar.
Best Time to Trade GBP/USD
Currency traders must know the most active times of the trading day for liquidity and volatility purposes.Learn more about the importance of currency volatility.
London Open (07:00 London Time): For GBP/USD, volumes will begin to pick up at the London open as market participants digest the events during the late US and Asian market session. Therefore, you will see a pick-up in momentum at this time, which also coincides with the European equity futures open. Alongside this, the ONS have recently have moved tier 1 UK data to this from 09:30 LDN previously.
New York Open (07:00 NY Time): While pound to dollar is a 24hour market, the most active and liquid time of the day is the LDN/NY crossover, which is generally the best time to trade the most liquid pairs. The crossover can occasionally be associated with a continuation of the moves observed in the European session. That said, it is important to watch closely for possible patterns in the LDN/NY crossover.
Average GBP/USD Intra-day activity over October 2019 to October 2020 (Time in GMT)
Tier 1 US Data (13:30 London Time): When trading Cable, you must be cognizant of the dollar side of the pair thus the tier 1 US data released at this time. Alongside this, other data points include Markit and ISM PMIs at 14:45 and 15:00 respectively.
London WMR Fix (1600 London Time): The WMR Fix is one of the most widely used benchmarks for FX trading, taking place every day within a 5-minute window around 1600 London time. The fix provides a standard set of currency benchmark rates so that equity and bond investors can compare portfolio valuations and performance with each other.
The WMR fix tends to coincide with a sharp rise in trading volume, prompting a sizeable increase in liquidity. Occasionally, this allows for large real money flows to take place without causing too many distortions. However, flows can also be dominant in one direction (strong buying or strong selling) leading to outsized moves in a very short period of time.
The largest bout of volatility stems from the month-end fix, taking place on the last business, where market extreme moves can often occur in the lead up during 15:00-16:00 London Time. These FX flows are derived from mostly equity rebalancing.
As such, if a UK portfolio manager holds US Dollar-denominated assets and seeks to hedge FX risk, then a monthly rise in the value of those assets will lead to more dollar hedging (selling the dollar). For example, if equities are FX hedged and US stocks (S&P 500) have risen on the month, while the FTSE 100 (UK stock market) has traded flat, then UK based investors would sell US Dollars against the Pound to add to their hedge, leading to an appreciation in GBP/USD. The greater the outperformance of US equity market over the UK would be associated with greater selling of the USD against GBP, prompting GBP to rise even higher. Although, extreme moves can often partially revert in the day following the month-end fix. That said, the occurrence of such event in a market as liquid as FX, suggests that the London fix (month-end fix in particular) is important for FX traders to watch for.
Illiquid Time zones: Even in the most actively traded currencies, there are liquidity risks. Particularly during the early hours of the Asia trade as both volumes and liquidity drops off.
GBP/USD Flash Crash (October 7th, 2016) | -6% in 3-minutes
Early in the Asian trading session, the Pound had depreciated near over 6% in a matter of minutes before quickly retracing much of the losses. While there was a lack of clear catalysts to drive such price action among the major factors that had played a role in the move was the time of day, which is typically associated with lower market volume, making for illiquid trading conditions. Another factor that seemed to have had exacerbated the decline was the surge in demand to sell the Pound to hedge options positions, while a GBP negative media report had also added a marginal weight, however, this had not been new information. Consequently, these factors had contributed to a brief halt in futures trading. Learn more about flash crashes.
Market Structure andKey Market Participants
Banks: Where most FX trading occurs either through initiation or facilitation.
Hedge fund: This is a private pool of investor capital used to trade in various asset classes equities, commodities, currencies and derivatives to generate superior returns relative to risk. Hedge funds can be classified in several ways:
- Macro funds: Using macroeconomic variables to forecast FX trends.
- High-Frequency Trading (HFT): Automated trading systems that use algorithms that can track numerous financial markets and execute vast amounts of orders.
- Real Money investor includes mutual funds, pension funds, endowments, insurance companies, and portfolio managers.
Central Banks control monetary policy which has a significant impact on FX markets via altering the money supply and interest rates.
- Tight Monetary Policy: Typically, when a central bank raises interest rates, the value of the country’s currency rises. This tends to happen as higher interest rates can attract capital flows into an economy with investors receiving a higher rate of return for the capital that they hold within that economy.
- Loose Monetary Policy: A more accommodative policy tends to place downside pressure on a currency, given that the increase in capital available tends to lead to inflationary effects. Consequently, this reduces the purchasing power of a currency making it less valuable.
- Jawboning: Central bank can move currencies without talking policy action by publicly advocating for a weaker or stronger currency through an implied threat to take action.
- Currency Intervention: A central bank can intervene through buying or selling the country’s currency has deviated substantially when from its monetary policy goals and at also at times of significant volatility in the exchange rate.
Non-financial customers (Mostly comprising of multi-national corporates):
- Cross-border M&A is an example of corporate activity that can result in sizeable FX flows. Consider a Japanese conglomerate, purchases a UK chipmaker in a £30bln deal. The view is that the Japanese conglomerate will need to buy GBP and sell JPY in large sums to carry out the transaction.
- Currency hedging needs are also carried out by exporters and importers every day.
Retail Traders: These include days traders who are trading on retail trading platforms.
Tips for fundamental trading
Fundamental analysis looks at how macroeconomic variables impact FX markets.
Risk sentiment: This can be a key driver for GBP/USD regardless of underlying domestic factors. The phrase you will typically see is “risk-on” if markets are up and “risk-off” if markets are trading lower.
Monetary Policy: Both globally and domestically, central bank policy is among the most important factors behind the direction of FX, given that it impacts interest rates. When trading GBP/USD, traders will have to analyse both the monetary policy actions and outlook from the Bank of England and Federal Reserve. As such, traders must read every speech from the monetary policy committee members, not only because this is what professional macro traders do but also even a slight change in guidance on monetary policy can be key the outlook for FX as markets are an efficient discounting mechanism.
For example, if the Federal Reserve hinted that they were looking to tighten monetary policy, while the Bank of England continued to maintain accommodative monetary policy. Interest rates differentials would begin to shift in favour of the US Dollar, attracting capital at the expense of GBP.
Geopolitics: In recent years, the influence of politics on FX has increased notably, thus it is key for traders to focus on it, particularly when politics can on occasions impact central banks via nomination of central bank governors. Alongside this, more specifically for the UK, Brexit has been a dominant theme since the UK voted to leave the EU in 2016.
Global Growth: The flow of capital is contingent on global growth.
Examining “economic indicators”play a vital role in fundamental analysis.
Key UK Data Releases
- Labour Market
- Retail Sales
- Markit PMI (Greater attention on Services PMI)
- Current Account & Trade Balance
- Manufacturing & Industrial Production
Key US Data Releases
- Non-Farm Payrolls (NFP) – First Friday of Every Month
- ADP Payrolls
- Initial Jobless Claims
- ISM Manufacturing & Non-Manufacturing PMI
- Retail Sales
- Durable Goods
- Housing Data (New Home Sales, Building Permits, Housing Starts)
- U. of Michigan Consumer Sentiment
Explore our comprehensive education content on using fundamental analysis in forex trading to learn more.
Tips for Technical trading
Technical Analysis, which is also known as charting involves the use of past price behaviour to guide trading decisions. Technical analysis tends to comprise itself of similar human behaviours in that markets can move in predictable ways with patterns showing that history also repeats itself. However, technical analysis is not without criticism with the approach often seen as subjective in nature, such as confirmation bias.
That said, technical analysis is an important tool to utilise for risk management purposes. For example, a trader may be bullish on GBP/USD, however, the trader can be at a loss of where to get into a trade, set a stop loss or where they will get out. This is where technical analysis can be beneficial.
Support and Resistance: This is perhaps the most popular use of technical analysis with the assumption that the price will bounce off a level on more than one occasion.
Reasons for support and resistance
- Round number bias: This is the tendency for humans to pay more attention to certain numbers and in this case round numbers. For example, on GBP/USD this could be 1.3000, 1.3050, 1.3100 and so on. As such, traders can have a preference to set limit orders or stop-loss orders at or near to round numbers. The chart below highlights as such with GBP/USD often bouncing off the 1.3000 handle
- FX Options: Sizeable option expiries can act as support and resistance as option traders look to remain delta neutral, in turn, spot prices can be magnetised to large option strikes.
Moving Average: This is another widely used technical indicator, which represents the average closing price of the market over a specified time horizon.
- Support & Resistance: Traders can use MAs as entry and exit levels. A trader may be bullish cable, but will wait to buy until the price is above the shorter timeframe MA.
- Mean Reversion: Over a period of time, markets can often mean revert to their long term MAs. For example, price can revert towards its 50/55 and 200 period moving average, which can be used to either confirm or question a current trend.
- Crossover Signals can be another way that traders use moving averages, where the shorter time period crossing above the longer time period would be a buy signal, while a sell signal would be for the shorter time period to move below the longer time period. The most commonly talked about crossover signal involves the 50 and 200DMA. Golden cross = 50DMA cross above 200DMA. Death cross = 50DMA cross below 200DMA. Crossover signals can also be used on shorter periods such as 5 and 20DMA as the example below shows. However, crossover signals can also be vulnerable to choppy price action, which sees a trade getting whipsawed.
Other technical indicators include:
- Pivot Points
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Correlation analysis: In a global market that is interconnected, FX markets can be driven by several variables, therefore, it is important to identify what is the dominant driver, which is why macro-based traders tend to lean on cross-market analysis. The beneficiary of this, is that it gives a trader a broader look at the market (as opposed to simply looking at their specific asset class), in turn this can help traders form an outlook.
There are however, two things to point out, a correlation does not equal causation and can sometimes be spurious. Correlations are also constantly evolving, which can depend on the market narrative at the time.
For those trading GBP/USD, traders are likely to follow these correlations:
- GBP vs other currencies: If EUR/USD is trading substantially higher, you can often expect GBP/USD to be trading higher in sympathy.
- GBP vs Interest rate differentials
- GBPvs Indices: In recent years, the Pound has become increasingly sensitive to risk sentiment. If the S&P 500 is outperforming, GBP/USD may also be underpinned.
- GBP vs commodities: With commodities priced in US Dollars (such as oil and gold), outperformance in commodities can highlight US Dollar weakness. However, the link between commodities and GBP/USD is somewhat tenuous as opposed to other currencies.
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