One of the smartest men I know, and a great trader and investor to boot, Dr. Bill Williams once told me that the smartest thing you could tell yourself was "I don't know". Implied in that sage advice is the equally valuable "never pretend to understand something you don't". I've been thinking of Bill's advice recently when considering the British Pound.
We have been focused on GBPUSD recently because the majority of its tradeable patterns have been lower since January 9th -- see Figure 1 -- and it has been behaving very nicely from a fractal perspective - each counter-trend rally is scaled nicely to the last on the intraday charts and this pattern continues to repeat itself.
While the pound has been sloping lower these past 7 trading days and took out the November low, its trip down has been a solo run. Both the Euro and the Aussie have been holding onto their January gains - we call this divergent behavior "negative interference". We know from experience that the largest moves in currencies occur when all the markets are pulling together, i.e.: the markets are correlated - we call this behavior positive interference. So the question is: is GBPUSD a leader on the way down, and does this weakness portend coming weakness for the majors? The correct answer for me is: "I don't know".
Figure 1. Risk Tolerance Threshold Ratio in GBPUSD
The price action in the pound has been great from our perspective. While we could see plainly that the Pound's run lower in the face of a steady Euro and Aussie was divergent behavior, that did not stop us from taking sell signals. When faced with divergence, or negative interference, we still take the trade, but initially manage it as a "counter-trend" trade, meaning we have a smaller profit target on the first portion of the position, and are quicker to go with a break-even stop. If the market cooperates and then accelerates in our direction, as the pound did, we switch to trending trade management on the balance of the position. But the question remains does the pounds recent weakness, which is divergent to the other majors, tell us anything about the overall market going forward? Yes it does, just as we initially treated sell signals in the pound as counter-trend trades because of the negative interference of the other majors, we also need to treat buy signals in the Euro and Aussie as counter-trend trades because of the interference created by the weaker pound.
From a macro perspective we still see the alpha market being USDJPY, albeit vying with last years alpha, the S&P 500. Should we see the major currencies break away from the alphas, as GBPUSD appears to have, it would not affect whether or not we take trades, but will affect the management of the trade.
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