The British Pound Plunge

Aug 14, 2008: 9:49 AM CST

With the rapid strengthening of the US Dollar Index, that means that many other currences that comprise the index have been plunging in value.  Let’s take a special look at the British Dollar and how spectacular that movement was.

British Pound (Currency iShares) FXB:

I chose to use the iShares chart rather than the British Pound Index ($XBP) so we could discuss volume implications.  Notice how volume was extremely low during the formation of this ‘line’ or rectangle formation, and then increased as a mini-symmetrical triangle completed before price plunged sharply to the downside.  This is a case where it might have been safe to assume that a triangle (or possibly larger rectangle) formation would have broken to the upside, but instead the pattern resolved sharply and suddenly to the downside with little warning as to how severe the move would be.

This development (unexpected break of a pattern and then a sudden surge against long positions) provides a clear example Dr. Steenbarger’s recent post “Mindful and Mindless Trading” where he discusses seeing a chart pattern and then jumping into the market based on that pattern without looking at the broader themes or reasons as to why a market might move (other than a solitary chart pattern), and also what happens when you do so and a market moves violently against you.

The new (and highly informative) Fresh Salt Water blog (written by a friend and regular reader) discusses the possible reasons behind this sudden move in the post “The GBP Slide” and I wanted to pull in a background quote:

“The UK made a decision some time back to not enter the Euro and for parts of this decade that decision looked to be paying off as it was held up as a shining example of a economic powerhouse in Europe. However, things are starting to go a bit wrong lately. The economy is slowing, UK consumers are mired in debt, the housing bubble which is now starting to burst rivals and on some measurements is actually worse than the US situation and inflation is rife. On the last point, recent inflation figures put the Retail Price Index at 5% – higher than the Bank interest rates. This is the first time since the early eighties that has happened. In addition, it’s unlikely the BOE [Bank of England] is in a position to rise rates to combat inflation (which would also strengthen the pound) due to the impact this would have on borrowers and the wider economy.”

Let’s also look at a larger timeframe structure to see what we could have learned from the weekly chart:

British Pound Weekly:

Here we see an upwardly sloping classic Head and Shoulders Pattern (that is more evident in the 3/10 Momentum Oscillator), the break of which would have signaled either a short entry or at least a long liquidation.  Price came back to test the neckline in March 2008 and then moved into a consolidation pattern (triangle) before breaking sharply lower on record volume.

Recall the bullish surge on the charts of the US Dollar Index (shown in my previous post “The Remarkable Strengthening of the US Dollar”) – there has to be a casualty of the dollar surge and those casualties are the currencies that make up the Dollar Index.

You can see similar bearish charts on the Euro ($XEU), Yen ($XJY, although not as severe a plunge as Europe), Canadian Dollar ($CDW), Sweedish Krona (FXS), and Swiss Franc ($XSF).

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