Sterling Testing Long-term Support

With so much turmoil in the marketplace most of the attention has been on the U.S. dollar and the euro; however, it is important to not lose focus on another major currency, which is the British pound.

Because of its close proximity to the euro zone, the British economy has been relatively sluggish but traders have been reluctant to punish the currency as much as the euro. The pound has been under some strong selling pressure in the last few weeks but still remains within a long-term trading channel. Investors should watch the currency closely because its recent strength in could all change if the market is heading into another down trend. What makes pound futures so interesting is the trading pattern it has created in the last year. Since mid-2010, the pound has been trading in a relatively tight channel with resistance around 1.65 and support around 1.54.

Last week, the sterling tested the bottom of its recent channel and closed Friday at 1.5432 because of renewed panic in the marketplace. If investors are going to trade the sterling they need to pay close attention to equity markets. Investors should also pay close attention to the VIX index; the more volatility in the marketplace, the higher the fear sentiment. The reality is that in these conditions, every time there is a boost in fear, investors jump out of risk investments and into the U.S. dollar and U.S. Treasuries. However the question is that is there enough fear to create a down-trend in the pound.

One of the hardest trading patterns to predict is a rectangle pattern; it is important traders pay attention to volume as will help determine the next trend. Although the pound is testing initial support, it is a little too soon to determine if there is enough momentum to push futures down further. We have entered the holiday trading season, which means we should see a drop in volume. We could see some short-term covering but this might not be enough to push prices back to the established resistance point. On the other hand there might not be enough buyers in the marketplace to support another run back towards year-long resistance levels.

On Oct. 6 pound futures broke below support and hit a low of 1.5179, which create some small buying momentum. Unfortunately, only a few weeks later, prices hit a high of 1.6158 and then they consolidated and then sold-off.

In these market conditions, a break below 1.54 could lead to a test of initial resistance at 1.50. This drop could create another small bounce as investors cover their position. If the buying volume is low then it is just a short-term bounce.

A break below 1.50 on high volume would lead to a test of long-term lows around 1.40.

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For more updates from Greg, be sure to visit his blog at TheTradingZone.com