Pound Sterling Pushes Higher in Classic Short-Squeeze Action

Pound Sterling Pushes Higher in Classic Short-Squeeze Action

11 April 2016, 14:29
Vasilii Apostolidi

The British pound is motoring higher as traders are forced to take profit on the sustained downtrend in the UK currency.

The GBP to USD conversion is pushing higher at the start of the new week with seemingly little by way of news to prompt the move.

This should come as no surprise to those who have been watching the pound exchange rate complex of late.

After all, the hefty declines witnessed in the preceding week came amidst a lack of notable news.

Yes 'Brexit' is the underlying sentiment-squashing factor, but we need to consider just what a role the technical structure of the market is playing.

Hence, we believe today’s rise in the GBP/USD exchange rate, and indeed most other sterling-based pairs, is s technical short squeeze / profit-taking move.

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How the Short-Squeeze Works in Favour of the Pound

Betting that the pound sterling could decline further against the dollar than currently reflected in the GBP/USD exchange rate clearly requires one to buy some kind of contract that buys dollars and sells pounds.

The move will play its own small part in pushing the GBP/USD lower.

The move lower will continue as more players jump in down the line and take out a similar bet.

Now imagine every man and his dog are doing this; the market becomes incredibly one sided.

When some small trigger reverses the price action, for whatever reason, you can bet there will be a number of stop-loss exit orders that will be triggered as traders look to exit the market on any reversal in direction.

The problem is that there are so many trades that are stopped out that very soon there is a cascade of pound buying and dollar selling.

Like a fire, it burns back down the line, tripping stop-loss after stop-loss. The moves can be sharp and violent in nature and for those who are not familiar with such scenarios can appear rather alarming.

Importantly though, they don’t last forever, and while they may alter short-term technical structures, they do not change the fundamentals.

Hence, we continue to forecast the pound to dollar exchange rate to continue to slip lower. 

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