Short GBP/USD Swing Trade Emerging

06/09/2011 6:00 am EST

Focus: FOREX

The Bank of England rate decision and a slow UK economic growth forecast may soon present a short swing trade opportunity for the GBP/USD currency pair. Here’s how to identify the set-up and play it.

The GBP/USD currency pair continues to trade in an ascending channel, one that has seemingly consolidated in recent weeks, as markets have digested poor economic data out of both the United Kingdom and the United States. Still, after the pair completed a corrective wave from the end of April through the third week of March, the pound rallied as the dollar slumped across the board.

The rally against the pound in May, or rather, into the Japanese yen, Swiss franc, and US dollar, has been the result of widespread risk aversion, as European sovereign debt fears have been ratcheted up over the past five-plus weeks.

With a rate decision on the docket for Great Britain that is widely anticipated to have a strong dovish tone, based on statements by Bank of England (BOE) members as well as shifting market expectations, a swing trade to the downside could arise for the GBP/USD pair, as traders seek to take advantage of weak risk appetite in the coming days amid a slower economic outlook for the European nation.

Key Price Levels to Watch

  • Range top: 1.6840 (trend)
  • Range bottom: 1.6110 (trend)

chart
Click to Enlarge

Potential Short Trade

  • Short: Place an entry at 1.6349 (50-period simple moving average (SMA))
  • Stop: Set the stop to 1.6546 (197-pip risk, last week’s high)
  • Target: The first target is 1.6228 (100-period SMA, move stop to 1.6309); second target is 1.6124 (76.4% Fib level)
  • Time frame: Three to five days

This GBP/USD short trade is predicated on the notion that the Bank of England will cut its outlook for the British economy, citing economic headwinds, and continue to sustain its accommodative monetary policy in order to try and jumpstart the economy.

NEXT: Key Drivers and Risk Factors for This Trade

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With the GBP/USD pair in the middle of a 700-pip channel, and sitting above significant moving averages on the daily chart, a dovish reaction by the markets could send the GBP/USD pair to its lowest levels in nearly three weeks.

Until the decision, the pair could continue its rise, as the relative strength index (RSI) continues to increase, at 60. The slow stochastic oscillator is trending higher, with the %K greater than the %D once more, at 73 and 68, respectively, suggesting that over the next two days, ahead of the decision, the pound could continue to see further gains against the greenback.

The Moving Average Convergence Divergence (MACD) histogram supports said notion, with the differential widening into a bullish divergence. With the pair sitting just above its 38.2% Fibonacci retracement of the move from March 28 to April 28, a fall below said point and meaningful follow through could expose the pair’s critical moving averages on a short trade opportunity.

See related: Using MACD to Find Good Trades

Event Risk

Today’s rate decision represents one of the most significant events on the economic calendar this week. Accordingly, with the Bank of England widely expected to leave rates on hold at 0.50% and keep their asset purchase program of £200 billion in place, and policy hawk Andrew Sentance leaving the Monetary Policy Committee last week, it appears that any commentary following the meeting could be more dovish than what has been said in recent months. (Click here for more commentary on this week’s rate decisions.)

That being said, despite an Organisation for Economic Co-operation and Development (OECD) report noting that the Bank of England should raise rates by year end, it appears that policymakers will indicate that they are willing to sacrifice a high inflation rate in order to leave continued slack in the economy.

By Christopher Vecchio of DailyFX.com

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