Changing Back To A Bearish Strategy On The British Pound

Jul.13.12 | About: CurrencyShares British (FXB)

After another pins and needles rally back to the 50DMA resistance, I think it is time to switch to a more bearish strategy on the British pound (NYSEARCA:FXB).

The British pound comes roaring back against the U.S. dollar but stops again at resistanceClick to enlarge

The British pound comes roaring back against the U.S. dollar but stops again at resistance.

Since mid-June, I have recommended buying the dips and selling the subsequent rallies on the British pound (also see "So Far So Good On Buying Dips In British Pound"). This strategy has been very successful, but this latest round has me considering reversing the strategy. Shorting at resistance over the past month would have provided precise entry points whereas by buying dips, I have had to accumulate a position until a subsequent rally took me out at a profit. I greatly prefer precision on entry because it is much easier to manage risk.

My earlier bullish bias assumed that the currency markets would turn more optimistic on the British economy with more credit flowing into the system. I also assumed that the U.S. dollar (NYSEARCA:UUP) would not break above resistance at its "QE2 reference price." Indeed, I figured a U.S. dollar trading at these levels would increase the likelihood that the U.S. Federal Reserve would roll out some announcement or program (QE3?) designed to relieve the upward pressure on the U.S. dollar. So, I am wary as I switch to a bearish bias because it now likely requires the U.S. dollar to eventually punch through this resistance in order to continue succeeding.

On June 1st, the U.S. dollar index pulled back on an intraday basis from resistance at the QE2 reference price. On July 11th, the U.S. dollar managed to close above this resistance. On Friday, July 13th, the U.S. dollar once again confirmed the importance of this resistance by sharply pulling back. If a reversal of Friday's losses does not occur next week, I will re-evaluate my bearish switch on the British pound.

In the meantime, supporting my more bearish outlook is the near constant sell-off of the pound against the Australian dollar. At a time when fears over the European sovereign debt crisis have driven the euro to major lows against major currencies, and a time during which fears are mounting about a global economic slowdown, the GBP/AUD currency pair has not traded in-line with risk aversion. In fact, it appears that currency traders are chasing a carry trade as the Australian dollar has surged against a whole host of lower-yielding currencies (for example, see "Australian Dollar Confirms Stock Rally As It Re-Emerges As A Leading 'Risk-On' Currency").

The Australian dollar has beat up on the British pound for almost two monthsClick to enlarge

The Australian dollar has beat up on the British pound for almost two months.

Source for charts: FreeStockCharts.com.

I am not making the Australian dollar (NYSEARCA:FXA) the centerpiece of my new bearish outlook on the pound because I recently switched back to a net bearish bet against the Australian dollar (for example, see "Remaining Bearish On Australian Dollar As The RBA Braces For More Financial Turmoil"). However, if financial markets overall become more bullish, betting against the pound with the Australian dollar will become quite attractive.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: In forex, I am net short the British pound and the Australian dollar.