How to short sterling
Created: 14 January 2009 Written by: Dominic Picarda
America's experiences today often become ours tomorrow. This is true across many walks of life. While the super-size menu and body-type may have been developed in New York, they are now just as common in Yorkshire. When it comes to our economy, the UK also now shares many of the worst characteristics of its American cousin.
The collapse of the American housing market foretold the problems that are now devastating the value of every Englishman's castle. And because both nations buy much more from the rest of the world than the rest of the world buys from them, both depend heavily on foreign lending to keep the show on the road. These factors have caused a massive drop in the US dollar against many other leading currencies over several years.
Why sterling will fall before it rises
Now, though, it is our turn. True, the US economy is still in an awful state. But having entered its crisis earlier - and taken steps to solve it earlier - there is a good chance that it will emerge from its malaise sooner. Our problems are likely to endure for a good while longer, given that we started to experience them later. And in many ways, our problems are actually bigger than those of the US.
Take the UK housing market. Compared to wages and to rents, British bricks-and-mortar became far more absurdly overvalued than American homes did. During housing crashes, prices tend to keep falling until long-term average valuations - or below - are reached. That still implies a big drop to come for UK housing, with some pundits calling for a 20 per cent fall in 2009. History shows that a weak housing market and weak sterling often go hand in hand.
Britain's indebtedness is also growing. Our government is having to spend heavily to soften the impact of the recession, which is going to lead the state's borrowing to balloon. As a result of our selling fewer goods and services to the rest of the world than the rest of the world sells to us, our current account deficit has also hit record highs. Both these factors are likely to weigh down further on the value of our currency.
Of course, sterling has already fallen long and hard against a whole range of other currencies. However, both the macroeconomic outlook and the charts suggest there is further pain to come. Admittedly, the pound has been trading lately near to 'fair value' of about $1.53. But currencies usually overshoot fair value when they're in a decisive trend such as the drop we've seen of late.
A 'head-and-shoulders' pattern suggests continued losses for sterling. From this, a price target can be derived in the region of $1.29. Other technical methods - such as the point-and-figure chart - also indicate the risk of losses into the $1.20s.
How to profit from the fall
Armed with this bearish view and these price targets, we might consider placing a 'one-touch' trade on the dollar/sterling rate. A one-touch is a fixed-odds financial bet that pays out if a price hits a certain level at any moment within a specific period of time. The further away the price we choose and the shorter the period of time we specify, the bigger the potential winnings.
Now, even though I believe that the pound could fall below $1.30, I also think it pays to be cautious. So, I'm going to set a one-touch level above here at $1.325. Because this is a big move, I'll allow myself a long time for it to come true - six months. At the time of writing - with the rate at $1.4551 - BetOnMarkets are quoting a return of 90 per cent for sterling to drop to $1.325 by 13 July.
In other words, a 9 per cent drop in this exchange rate will allow me almost to double my money if I'm right. There's no need for risk-management here: if I'm wrong then I simply lose whatever stake I put down.
Created: 14 January 2009 Written by: Dominic Picarda
America's experiences today often become ours tomorrow. This is true across many walks of life. While the super-size menu and body-type may have been developed in New York, they are now just as common in Yorkshire. When it comes to our economy, the UK also now shares many of the worst characteristics of its American cousin.
The collapse of the American housing market foretold the problems that are now devastating the value of every Englishman's castle. And because both nations buy much more from the rest of the world than the rest of the world buys from them, both depend heavily on foreign lending to keep the show on the road. These factors have caused a massive drop in the US dollar against many other leading currencies over several years.
Why sterling will fall before it rises
Now, though, it is our turn. True, the US economy is still in an awful state. But having entered its crisis earlier - and taken steps to solve it earlier - there is a good chance that it will emerge from its malaise sooner. Our problems are likely to endure for a good while longer, given that we started to experience them later. And in many ways, our problems are actually bigger than those of the US.
Take the UK housing market. Compared to wages and to rents, British bricks-and-mortar became far more absurdly overvalued than American homes did. During housing crashes, prices tend to keep falling until long-term average valuations - or below - are reached. That still implies a big drop to come for UK housing, with some pundits calling for a 20 per cent fall in 2009. History shows that a weak housing market and weak sterling often go hand in hand.
Britain's indebtedness is also growing. Our government is having to spend heavily to soften the impact of the recession, which is going to lead the state's borrowing to balloon. As a result of our selling fewer goods and services to the rest of the world than the rest of the world sells to us, our current account deficit has also hit record highs. Both these factors are likely to weigh down further on the value of our currency.
Of course, sterling has already fallen long and hard against a whole range of other currencies. However, both the macroeconomic outlook and the charts suggest there is further pain to come. Admittedly, the pound has been trading lately near to 'fair value' of about $1.53. But currencies usually overshoot fair value when they're in a decisive trend such as the drop we've seen of late.
A 'head-and-shoulders' pattern suggests continued losses for sterling. From this, a price target can be derived in the region of $1.29. Other technical methods - such as the point-and-figure chart - also indicate the risk of losses into the $1.20s.
How to profit from the fall
Armed with this bearish view and these price targets, we might consider placing a 'one-touch' trade on the dollar/sterling rate. A one-touch is a fixed-odds financial bet that pays out if a price hits a certain level at any moment within a specific period of time. The further away the price we choose and the shorter the period of time we specify, the bigger the potential winnings.
Now, even though I believe that the pound could fall below $1.30, I also think it pays to be cautious. So, I'm going to set a one-touch level above here at $1.325. Because this is a big move, I'll allow myself a long time for it to come true - six months. At the time of writing - with the rate at $1.4551 - BetOnMarkets are quoting a return of 90 per cent for sterling to drop to $1.325 by 13 July.
In other words, a 9 per cent drop in this exchange rate will allow me almost to double my money if I'm right. There's no need for risk-management here: if I'm wrong then I simply lose whatever stake I put down.
