Forex Trading and Brexit – The Risks

In case you haven’t heard the UK government are holding a referendum on whether to continue with Britain’s membership of the European Union. On 23rd June the UK population will go to the polls and with a simple choice of YES or NO to decide the future position of Britain in the EU.

The referendum is being held due to an election pledge made by the now Prime Minister David during the 2015 election campaign. This is the first time a referendum has been held on this issue since 67% of the population voted for continued membership of the European Economic Community in 1973.

Here we take a look at some of the key opportunities and risks of trading Forex around Brexit issue.

What Is Brexit?

Vote leave campaigners have coined the term BREXIT to describe the potential for Great Britain’s possible exit from the European Union (BRitains EXIT).

Voters will be given the one simple question in the referendum that will determine the future direction that Great Britain takes:

“Should the United Kingdom remain a member of the European Union or leave the European Union.”

What are the arguments of each side?

Remain campaigners argue that to leave would be disastrous for the UK economy and that continued membership conveys a number of benefits. These include chiefly economic reasons such as providing trade agreements, investment and jobs.

Issues of border security have also been raised; however claims that the hegemony of Europe may be broken by Britain’s exit seem somewhat far-fetched.

The Leave campaign has largely focused on Nationalist issues. These include Britain regaining it’s own Sovereignty, allowing it to negotiate its own trade agreements and implement tighter immigration policies.

Current fiscal contributions to the EU for membership are also highly contentious. Leave campaigners have been citing net contribution of £8.5 billion per year.

It is fair to say that both sides have been heavily criticised for the lack of factual detail given in arguments for their campaigns.

What Does This Mean For Markets?

trading forex around brexit vote
Sudden 50 pip spike indicative of the volatility as Brexit vote nears.

One thing is for certain; markets don’t like uncertainty.

Trying to enact a trading strategy at this time is difficult as markets are being driven on heightened levels of fear and emotion As the referendum draws nearer we will without doubt, see even further increased levels of volatility.

This will inevitably make trading calls not only more difficult but more risky and we have already seen some unusual price spikes occurring.

Those of a nervous disposition are advised to switch off their screens now.

Here we have put forward some key things to consider if you can’t resist trying to ride the referendum roller coaster over the coming weeks.

Fundamental Data

Fundamental data is less likely to have as much effect on GBP pairs in the run up to the referendum.

Yes, markets want to see how the UK economy is doing, but the referendum cloud has potentially far greater repercussions for the value of Sterling. With this in mind the big traders such as Banks and Hedge funds are less likely to take a position until they know the outcome.

Despite a brief rally over the last week, Sterling has been falling as traders de-risk their positions in the event of the UK leaving.

Don’t expect even good figures from the UK economy to have as much impact as they would without the shadow of the referendum. Nevertheless you still need to factor key events into your trading.

Upcoming news of note on the Forex calendar includes –

  • Tuesday 14th – USD – Core Retail Sales
  • Wednesday 15th – GBP Claimant Count Change, USD FOMC Press Conference
  • Thursday 16th – GBP  B of E Rate Decision, USD Unemployment Claims
  • Wednesday 22nd – USD Crude Oil Inventories
  • Thursday 23rd – UK REFERRENDUM

Polls

A big mover of markets leading up to the event will be opinion polls which provide an indicator as to the likely direction that a vote may go.

While the initial Polls seemed to show the population favoring to remain, more recent polls seem to show the leave camp gaining the initiative.

While all opinion polls need to be taken with a pinch of salt, the key points to take from them are

  • It is very close
  • There is a large undecided minority

Whether this minority will swing to the ‘Yes’ or ‘No’ camp remains to be seen as the ‘for’ and ‘against’ arguments continue to rage. Despite the importance of the vote it also seems likely that many voters will choose to abstain.

Analysts

Financial analysts are notorious for getting it wrong.

While it is generally accepted that a leave vote is expected to see an immediate weakening of Sterling there is little consensus as to the long term repercussions of Brexit.

Medium and longer term predictions for Sterling are much harder to make. Various projections have been made and have seen GBP currency crosses react. A vote for leave could see additional stimulus, inflation and possibly an early Bank of England rate rise.

Technical Analysis

Big picture, GBP/USD seems to be moving to the bottom of a channel and is firmly planted below both the 100 Day and 200 Day moving average.

gbpusd brexit forex trades

Some fairly significant trend line support exists below current levels. Without the referendum we would possible look for a corrective move higher, back towards the top of the channel in the 1.4600-.14800 region. However technical are not driving market direction at present.

Don’t forget that it’s not just Sterling (GBP) related pairs that will we affected by this vote. Currency shifts and ‘risk on’, ‘risk off’ flows will be seen across many other markets.

Brokers

The abandonment of 1.20 floor in the EUR/CFH by the Swiss Central Bank in January 2015 and the subsequent fallout should prove something of a cautionary tale for those intent on trading into the referendum announcement.

The subsequent 30% drop in the pair was felt by both traders and brokers alike. Two of the biggest brokers found themselves with a lack of liquidity; FXCM had to seek a bailout and Alpari UK ended up going bust.

Many traders also suffered huge losses as brokers looked to reclaim funds from high margin calls caused by the sudden moves.

While hopefully lessons have been learnt, it pays to be cautious.

Holding open positions into the weekend or over the actual vote may not be the smartest move for your account.

While we would all like to think we can be on the right side of the move, events over the next week or so are BIG news and pose a SERIOUS TRADING RISK. This is not a case of potentially losing a few pips. You really could see your account blown.

Summary

A successful Forex trading strategy should offer three states that the trader can take. Going ‘long’ and ‘short’ the market are the two obvious trades to make.

The third state is to do nothing. Yes, really. Sitting it out is a perfectly valid and reasonable third trading position to take.

While the Brexit vote may not an unforeseen Black Swan, it nevertheless has the potential for improbable outcomes.

As traders we look for repeatable trading outcomes, but here what we are faced with has no precedent.  In this scenario, the third trading position where we avoid risk and protect our capital could prove to be the smartest Brexit trade to take.