Gain a Few Pounds with British Stocks
I've been anticipating the devaluation of the British Pound for some time now, however now that we have what appears to be confirmation, let's take a look at how we can profit.
For a quick reference, when a Central Bank of any country who issues it's own currency (such as the US) decides to provide a seemingly endless supply of liquidity to markets during a deflationary economic environment, what happens to the stock market of said country?
S&P 500 Straight Up since March 2009 Lows
I'm not an advocate for worrying about the "Currency Wars" that seem to be getting quite a bit of attention over the past few years. It doesn't mean I disregard facts and economic issues surrounding the impacts of currency devaluation efforts of multiple governments at the same time, but I do not have any control over these events. The only thing I can do is use the price action of stocks, bonds, commodities, and currencies to help me determine the best course of action for portfolio positioning.
Back to the pound. Britain has been hard at work to devalue their currency. Remember, the UK did not adopt the Euro, which means they do not have the same issues to contend with as countries like Germany, Spain, Italy, Greece, etc. Trader's have slowly but surely taken notice, and the price of the British Pound has now broken down through a symmetrical triangle pattern as shown on the weekly chart below (FXB is the ETF which tracks performance of the British Pound currency).
Pound breaks down on confirmed deceleration in momentum as measured by the RSI
If we check in on the UK stock market on a weekly chart, we'll notice it has held up quite strongly this year, unlike other European countries.
UK Stock Market trying to retrace to old highs
The UK stock market is attempting to retrace to old highs from 2007, similar to the US market. When stock's break out of consolidation patterns to the upside, many old gaps and previous targets from years back become noticed by traders and investors alike. It's almost as if they become magnets, just waiting to be tagged. Keep in mind, heavy selling is likely once these targets are reached, so selling into strength as upside objectives are hit is highly recommended.
If we drill down to the daily chart of ticker EWU (this is the ETF for the UK stock market), we can see price action is showing a bit of a pullback starting, which will likely reach down to the $17.60 area before finding solid support. I'm watching this closely as any signs of a turn up from here will likely lead to a retest of old highs. If momentum breaks down from the range shown on the chart, no entry is advised from my viewpoint as this is typically a warning of weaker price action to come.
EWU pulling back a bit
What I find interesting is the similarities in the breakdown of the British Pound and potential strength building in UK equities as has been the case in the US when the Fed continues with announcements for more monetary easing and our stock markets jump. Risk is defined quite well by the daily chart for UK equities as price action breaking below the 17.50 range is an acceptable stop level for a trade. The weekly chart displays the target potential. This is a solid options play candidate for buying out of the money calls on EWU, or even selling out of the money puts as price nears the $17.60 area (strength in momentum should confirm before using this sort of strategy).
- Buy EWU at $17.60 if price action firms up with momentum. Target $19 - $20. Stop below $17.50.
- Buy slightly Out of the Money Calls as price nears $17.60 (premiums cheaper). Strike of $18.00 for April expiration.
- Buy FXB Puts with a Strike of $145 for June Expiration. Target price is $142 for FXB, so keeping a higher strike allows some room for error.
Using recent US stock market history as a guide may prove profitable for those looking to trade a UK stock bounce while Britain tries to shed a few Pounds.