With all eyes focused squarely on the FOMC’s March 15th meeting and the associated interest rate risk, we’ll present a currency setup in the British Pound futures that could provide some serious bang for the margined Dollar.
The British Pound futures have been consolidating since the Brexit vote last June. Major global currencies rarely move as far and as fast as the Pound did following the Brexit vote. Major currency dislocations make it tough for international businesses to operate. After all, the point of doing business in Dollars or Sterling is the relative stability their backing governments provide. There are two ways to rebuild confidence following a significant market dislocation, price and time. The price can revert to its previous levels thus mitigating the initial shock of the disruption or, prices can remain at their new levels for an extended period allowing the trend and the marketplace to adjust to the newly established price level. Thus, the sideways action over the last several months has allowed the market to adapt to it new trading range.
The previous example is also illustrative of the commercial traders’ behavior in the commodity markets. Commercial traders are value players executing a business plan. When they do their job well, they generate alpha through the skillful placement of hedged positions based on their financial needs and their supply and demand outlook. This creates two broad characteristics that are worth tracking. First, we follow their momentum to determine which side of their value consensus the market is currently trading. Are they net buyers or, sellers? Secondly, we track their current positions against their historical positions to determine how much capacity they have in reserve.
We want to use their estimation of value to our advantage but, we don’t have their pockets. Therefore, we wait for the market to become overbought or, oversold against their consensus. The British Pound futures are currently oversold on our short-term market momentum indicator. The commercial traders’ collective momentum is positive, and the current readings of their net and total positions are within spitting distance of their respective records. Combining these factors, we end up with a market that is in a severe state of internal conflict. The commercial entities are confident that owing British Pounds near $1.20 is a good idea while the speculators continually push for the next leg of the trend to extend.
The near-record conflict brewing between the commercial and speculative traders will provide the fuel for the reversal setup. Our plan is to use the speculators’ typical lack of success against them. They are currently trying to press the market to new lows versus the Dollar, and we are content to let them. The speculators are currently within 10k contracts of their record net short position and are carrying a total position that is less than 3% from its record. Meanwhile, the commercial traders aren’t even within 40% of their total position record. The point is, the speculators are near their max while the commercial traders have the power to spare.
This brings us to the chart below. We expect that a reversal higher and a close above $1.2250 will begin to trigger some speculative short covering. We will go long when the speculators realize they’re wrong and place a protective sell stop just below whatever the swing low turns out to be. The speculative short covering of a position this large could be fairly substantial.
The large market imbalance between the commercial and speculative traders could create quite a show following the FOMC meeting.
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