The best technique for trading the pound against the dollar

Several readers have asked me to cover the pound against the US dollar (I shall call this cross-rate the GBP). Many of you who are UK residents have a deep interest in this rate, and it is one of my major trading vehicles.

Many people in this country like to trade GBP, but seem to have difficulty making profits.

I believe this is because it tends to be ‘spiky’. In other words, the moves often carry further than you think they should, and then reverse. This can be very frustrating, especially if you are using a close protective stop.

But this market conforms beautifully to the Fibonacci system of determining turning points, especially on long-term charts. As I showed in the shorter-term AUS/USD charts, using Fibonacci concepts can seriously increase your win rate – and keep you out of trouble by allowing close stop placements. A winning combination!

Let’s have a look first at the long-range GBP chart.

Sterling v US dollar

(Click on the chart for a larger version)

The pound rallied in 2006 and into 2007, but in November, started a huge bear market taking it from $2.11 (ah, those were the days!) to $1.35 in January 2009. This was a 36% decline in a year or so.

Playing the rebound in the pound

Naturally, the selling was overdone, and the market started to recover in the spring of 2009. I could then apply my Fibonacci tool to those two pivot points (marked in green).

But note the points I have marked with the purple arrows. Coming off the $2.11 top, the market bounced off these levels, which just happen to be at the Fibonacci 23.6% retracement of the subsequent entire down move. It is as if the market knew this was an important level before it had made the final low at 1.35!

It seems magical. But we can understand it if we remember what the Fibonacci sequence actually describes – the growth and decay of natural systems in a mathematical format. Just by knowing the shape of the initial wave we can estimate the final size of the large wave with high probability. This is useful knowledge to have.

The rally into the summer of 2009 was a little too enthusiastic, as it overshot the Fibonacci 38.2% level. But then, the market began a choppy decline that took it to the $1.42 area in May 2010.

Because the May drop had occurred on a potential positive divergence with momentum, I was expecting a low to be put in with high probability.

Let’s have a closer look at this wave:

Sterling v US dollar

(Click on the chart for a larger version)

I have applied my Fibonacci tool to the pivot points and right away, we can see that the drop from pivot 2 bounces off the Fibonacci 38.2% retrace level again (see the first purple box), before moving lower, then bouncing off the 61.8% level (see the second purple box), and finally turning around from the 76.4% level (the third purple box), where we have the positive divergence with momentum.

What a stunning demonstration of Fibonacci order in the markets this is.

How to use these turning points

With these high-probability Fibonacci turning points on the weekly chart, a trader can build a good long-term trading programme.

A good strategy is to enter resting buy or sell orders (depending on whether you have a dip or a rally) close to these Fibonacci levels.

When your orders are filled, you would enter your protective stops using a good money-management rule, such as my 3% rule.

If stopped out, the market will probably go to the next Fibonacci level, where you could repeat the process until you have found the turning point.

Of course, if you do trade in this fashion, you do not need to check your trading screen very often – once daily is probably enough.

And. as I have shown on other posts, this method works just as well on short-term charts.

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