GBP/USD: The Failure Trade

Our approach to trading could be categorised as trend followers, as in we like to trade in the direction of the prevailing dominant trend. The reason we believe in trading in the direction of the longer term trend is simply because trending price action offers the highest probability of success.

However, there are occasions; very specific circumstances when the right trade is actually counter the dominant trend. I know this sounds very contradictory, but I hope by the end of this blog you’ll see that this type of trade can be very profitable.

As a trend follower the bias is to buy or sell when price action breaches key levels. The thinking behind this strategy is that stops are placed behind major levels, so breaking one of these levels can lead to momentum moves. However, this does always pan out as we’d expect, and in fact price ends up reversing aggressively in the opposite direction. This happened today, and we profited from it.

GBP/USD is in LONG term range bound market capped by lower support at 1.5270 key level, and upper resistance on the 1.6300 key levels. Price has failed to forge a sustained break of these since July 2010. That’s a pretty long time, right? Have a look at the weekly chart.

GBP/USD Weekly Chart" title="GBP/USD Weekly Chart" width="600" height="575">
Price action on the daily chart shows the most recent rally from the lower support up to resistance at 1.6300. As price approaches this level trend followers are seeing a technical uptrend, and will be eager to add on the break of the 1.6300 key level.

We however have put price in to context and know that the 1.6300 handle has acted as major resistance on numerous occasions. Traders will need a strong reason the force cable higher, and with no fundamental driver this looked highly unlikely. So, we took a position in the opposite direction to the recent trend.

We watched price breach the 1.6300 handle yesterday. Cable bulls buying through this level were anticipating the execution of buy stops and a momentum move higher. If this happened, then no problem, we miss out on this occasion. As price action unfolds sellers enter the market and drive price lower, back below the 1.6300 handle. Now we’re on the lookout for shorts.
GBP/USD Daily Chart" title="GBP/USD Daily Chart" width="600" height="575">
Cable sets a fresh daily low at 1.6220, but close slightly above this level. Now we’re looking for price to fall below the daily low to confirm the bears are in control. Entry is on the break of the 1.6220 level. Stop above the swing high above resistance at 1.6300. Profit target 1:1.
GBP/USD - 4 Hour Chart" title="GBP/USD - 4 Hour Chart" width="600" height="575">