Brexit Fears Are a Good Opportunity to Trade the British Pound

 | Feb 23, 2016 | 2:00 PM EST
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This commentary originally appeared on Real Money Pro at 11:00 on Feb.23. Click here to learn about this dynamic market information service for active traders.

The British pound took a pounding yesterday after London mayor Boris Johnson announced that he supported the separation of the United Kingdom from the European Union. At one point, the news pushed the British currency lower by 2.4%, to its weakest level since March 2009. A referendum will be held on June 23 to determine whether there will be a British exit, or Brexit, from the E.U.

Some of the current polls indicate that a Brexit is unlikely. Despite this, the British pound is being priced for disaster. Do the polls have it right, or are the traders correct? Even without knowing who the eventual winners and losers will be, a trading opportunity may be about to present itself.

One glance at the British pound/U.S. dollar (GBPUSD) chart shows that the British currency has already lost over 17% of its value against the dollar since the exchange rate peaked above $1.70 in July 2014 (point A). That's a big move in the currency markets, as is the plunge from above $1.52 (point B) to nearly $1.40 that has occurred over the past three months. Notice that the weekly RSI (relative strength index) is nearly oversold, at 32.33; any reading below 30 indicates an oversold condition.

Source: TradeStation

Now take a look at the monthly chart, and note that $1.40 (blue line) has been a major support level for GBPUSD for the past three decades. In this timeframe, RSI is close to oversold levels for the first time since 2009.

Source: TradeStation

Does this mean we should buy GBPUSD at or near $1.40? Not necessarily. However, it does tell us that plenty of bad news is already priced into the British pound. That bad news might never materialize.

I wouldn't be surprised if the U.K. is downgraded by Standard and Poor's and/or Moody's within the coming weeks. A downgrade might push GBPUSD well below $1.40, into extremely oversold territory.

Let's review the most recent instance of a U.K. downgrade. On April 19, 2013 (shaded yellow), ratings agency Fitch downgraded the U.K.'s credit rating from AAA to AA+. That day, the British pound traded near $1.53. Instead of Brexit fears, the controversy at the time centered on austerity measures.

Source: TradeStation

In hindsight, one can see the spectacular buying opportunity that followed. A little over a year later, the British pound had rallied from $1.53 to over $1.71. The day of the downgrade was the perfect time to buy.

I fully expect downgrades as a result of the uncertainty surrounding Brexit. The best time to buy the British pound will occur sometime shortly after those downgrades. 

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The dollar index ended up holding support nicely into both the time and price parameters discussed last ...

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