GBP/USD: using sterling to dollar sentiment to trade Brexit uncertainty

GBP/USD client sentiment - talking points

• The British pound (GBP) has fluctuated in an 800-pip trading range relative to the US dollar (USD) so far this year with currency volatility stoked by the latest Brexit developments
• GBP/USD could remain rangebound over the medium term as the forex market awaits Brexit clarity
• Forex trader positioning and client sentiment data from IG can facilitate range trading and help identify potential trend changes

The latest Brexit developments have dominated GBP price action since the June 2016 referendum when the UK voted to ‘divorce’ from the EU. While the political and economic landscape across Great Britain – in addition to the direction of the pound – remains overshadowed by vast uncertainty surrounding the final outcome of Brexit, GBP/USD may offer unique forex trading opportunities.

Learn more about Brexit trading opportunities

GBP/USD has climbed steadily, owing to the depreciation of sterling relative to the dollar. Brexit has inarguably bludgeoned the pound, with the most recent influx of ambiguity regarding who will take the reins of Parliament and replaces Prime Minister Theresa May when she steps down on 24 July keeping GBP/USD bid.

Brexit uncertainty could lead to trading opportunities

Yet, a lack of fundamental clarity across the UK due to elevated levels of uncertainty has potential to foster a well-defined trading range across sterling currency pairs, like GBP/USD, as forex traders struggle over sterling’s next direction. As such, while currency traders await clarity on May’s successor, and the several Brexit unknowns, GBP will likely remain range-bound with a certain degree of short-lived episodes of volatility in reaction to the latest Brexit headline coming across the wires.

GBP/USD currency price chart: daily timeframe

That being said, currency traders may find interest in using IG client sentiment data for GBP/USD, which has potential to expose shifts in currency price action such as the continuation, pause or reversal of a prevailing trend or range. Used in combination with more conventional fundamental and technical analysis GBP/USD indicators, IG client sentiment data is similar to the Commitment of Traders (COT) report published weekly by the Commodities Futures Trading Commission (CFTC). However, market positioning data provided by IG is updated twice daily and reveals market sentiment from the perspective of retail forex traders.

How to use forex client sentiment successfully

Broadly speaking, retail forex market participants have short-term trading perspectives and aim to enter positions at the tops and bottoms of price action prior to an anticipated reversal rather than adhering to the colloquial ‘the trend is your friend’ mantra. Considering retail traders tend to operate with bad habits and struggle to develop a well-proportioned strategy, their sentiment is generally viewed as a contrarian indicator.

That said, analysing IG client sentiment data through a contrarian lens is not always appropriate. In fact, evaluating changes in retail forex trader positioning can serve as a possible gauge for identifying a crowd-intended reversal in price action – particularly when the underlying market itself is more aligned to natural range conditions.

British pound client sentiment: daily timeframe

Assuming that sharp moves in the pound will likely be put on pause until the UK elects its next Prime Minister, incorporating IG client sentiment data into a comprehensive trading strategy has potential to add value to a currency trader’s analytical approach. According to trader positioning data as of 26 June, we can see that 71.1% of forex retail traders remain net-long spot GBP/USD with a long-to-short ratio of 2.46 to 1 and indicates a bullish bias.

GBP traders’ bullish bias on the wane

However, the change in client positioning since the beginning of June reveals that GBP retail forex traders’ bullish bias has recently waned as the number of traders net-short has gained on those holding net-long exposure. This could largely be due to growing prospects that Member of Parliament (MP) Boris Johnson may win the race to become the next Prime Minister, which raises the risk of a no-deal Brexit. The possibility that underdog MP Jeremy Hunt wins over conservative party majority has potential to limit GBP downside until the Prime Minister election process is finalised.

Consequently, with the alignment of a clouded fundamental environment driven by UK political uncertainty and the change in GBP client sentiment since 14 June, the recently-defined trading range between the $1.25-$1.28 handles look to hold over the medium term. Continuing to monitor changes in IG client sentiment may provide additional weight to this scenario as it unfolds.