Sterling appears to be carving out a potential head and shoulders topping pattern. If this pattern is valid and the neckline breaks, it could signal a retest of the multi-year lows set in April near $1.45.
Recall that the euro had put in its low in late March near $1.0460. Sterling's put in a low a couple days before the euro but then made a new lows a month later. The euro did not make a new low then.
Sterling then went on to rally 12.5 cents from $1.4565 to $1.5815. Part of this was the generally weaker US dollar environment and part of this was a function of the surprising election results. Since mid-May sterling has chopped lower.
This Great Graphic, composed on Bloomberg, shows sterling's performance. The left shoulder was created on the pre-election spike in late-April that carried it up to $1.55. The right shoulder appear to have been carved out last week. The neck line, depicted by the white line, is drawn off the pullback after the left shoulder and before the right shoulder. It is found near $1.52. It is upwardly sloping, which is what technicians like to see in a topping pattern.
The neckline corresponds to two other technical levels. The first is the 100-day moving average (purple line). This average caught the February high. Although it was violated in late April, buying sterling as it broke above would have allowed short-term traders to catch the construction of the head of the pattern. It comes in now near $1.5175.
The second is the 50% Fibonacci retracement objective of the mid-April through mid-May rally. That is found just below $1.5200 (blue line). The 61.8% retracement target is found near $1.5045.
There are two ways to play this. First would be to buy sterling with a stop below the neckline, and ideally below the 100-day moving average. To play sterling from the long-side, the initial target may be last week's high near $1.5440. A secondary target would be in the $1.5500-50 area. The second way would be to wait for sterling to break the neckline to short it. A caveat is often is seems that after a break of the neckline of a head and shoulders pattern, there is some follow through selling before the neckline gets tested from the other side.
There does not appear to be a right or wrong way to play the potential head and shoulders pattern in sterling. It depends on one's own style, view, and risk tolerance.
disclaimer
Great Graphic: Potential Head and Shoulders Top in Sterling
Reviewed by Marc Chandler
on
June 08, 2015
Rating:
Reviewed by Marc Chandler
on
June 08, 2015
Rating:
