If you haven't heard the word Brexit you must have lived under the rock. The citizens of the United Kingdom decided, by a narrow margin, to leave the European Union in a nationwide referendum, held on the 23rd of June 2016. This is a monumental event and its immediate consequences are far from clear at this point in time. However, we will try to analyze how this outcome, viewed as a piece financial news, has affected the markets and what lessons we can learn from it for the future.
Buy the humour ...
News feeds is a subjective information source and great food for a contrarian. This is what I read in the news on June 23rd:
- Britain's Bookies: Odds Are U.K. Will Stay In EU
- Britons queue to exchange pounds ahead of referendum
- EU referendum odds: Remain vote has always been bookies' favourite – and odds continue to shorten
This is what I saw on the charts of GBP/USD pair - pay attention that the ramp - a 7% rally - started about four days before the referendum
This is how FTSE chart looked like last 2 weeks. Rather similar story with a strong rally last week
And a failure of what would otherwise be a perfect bearish setup
Finally I chatted with my UK based friend who was sure about who was going to win and expressed an opinion that GBP, already touching at 1.50, will run higher when the poll results go out.
A short side note here for the readers who do not posses trading experience. A winning trade - I mean a high probability winner because the future prediction is not an exact science - consists of three elements:
- A trading plan
- A will to act - place the order
- Readiness to close the position and pull the profit or accept the loss.
A trading plan involves reasonably good theory preferably based on statistics, past experience and reasonably good knowledge of available financial instruments.
A contrarian inside me was whispering that it is over for GBP rally or almost over. Lines to changes in London like it is August 2015, Moscow? The pending demand for euros worth weeks or even months of sales is getting flushed down at the highest exchange rate for GBP in half an year. Who are the buyers? They are most definitely not forex traders. A forex trader knows how to hedge without going to a currency exchange store. My friend who is not a forex trader either thinks that GBP will continue to rally on top of 7% it ticked already.
London bookies? They are in business of pocketing spread not betting on the hard to predict outcomes.
There was a dent in this almost perfect contrarian picture. Options traders remained complacent, keeping the premium low and pricing in that the status quo is not going to change. Another problem was a failure of what would be a text book example of a broken trend line and Head&Shoulders formation
A trader in me pays notice to charts. Charts often express opinions of smart money. Betting against smart money is not a smart way to speculate unless you are looking for a "wealth hedge".
My past experience was reminding me "Buy the humour, sell the news". The humour was pretty much baked in in the assets prices. I expected an anticlimax after the poll results get out. I did not know what the result is going to be and I did not care. My theory was that it does not matter. The worst scenario for me - I was going to bet agains the prevailing opinion - was a 0.1-0.2% spike in GBP followed by a drop all the way back to where it was last 3 years or about 1.4.
In terms of FTSE a clear break of the price above the Head&Shoulders pattern on reasonable volume would take me out of the trade.
Available instruments are ES (SP-mini) futures, out of money options for UK/US ETFs, GBP/USD pair, EU ETFs.
Entry point was where SP500 touches that upper trend line of the widening triangle or as close as possible to that point.
I did not act. I was lacking a will to act. I have had a good reason not to - I was short SP500 via SP500 minis rather heavily already and about 50 SP500 points under the water. I had also volatility shorts because I always have them. I sold out of money puts against my volatility short to offset the margin costs and did not touch anything else.
The end game
Twenty four hours later I was covering 8 out of 12 ES contracts for an overnight gain of 100+ points per contract or $40K. I was covering the contracts in premarket based on the touch of the lower trending line of that widening triangle from the trading plan. GBP was trading under 1.40. My UK friend was accidentally online and told me that GBP is heading much lower, that they are going to sell it fast and hard. I placed a buy order at what proved to be 10 points higher than the Globex low.