Will hedge funds start to lose money in sterling?

As my long-time readers know, I have a thing against hedge funds.  First, they have veered a very long way from their original objective which was to offer investors a way to short stocks in a down market as well as hold onto core holdings.  That was the meaning of  the term ‘hedging’ – to arrange a short offsetting sale to preserve accumulated gains on investments.

The original hedge funds held mostly medium and long term investments.  Few engaged in short term trading.

But today, with electronic instant trading and super low commissions available, the picture has changed radically.  Many employ robot traders called robo traders or algo traders.  These use algorithms to direct trading – and high frequency trading is an offshoot.  I don’t recall the exact percentage, but I read HF trading accounts for about 40% of volume on the NYSE.

These boys are very big players – and have massive resources (and trading funds) and employ many of the brightest talents around.  In a way, they have come to dominate many markets and I am convinced they are in cahoots with central bank people to front-ride postions. That is why I really enjoy taking money off them – and I do that because I know they herd.

I have recounted on my blog how I have done just that in many of my trading exploits.  The latest was to short gold just as hedge funds had overloaded the boat on long positions at the back end of September.  I rode gold down from $1320 to the recent low at $1250 for a handy $7o per oz profit.

And I smell another great opportunity in GBP/USD to repeat the process.

Unless you have just arrived from Mars, you will have read all about the Sterling Crash.  This story is gathering acres of copy with the accompanying dramatic headlines.  That makes sterling a candidate for using my Headline Indicator (HI) as a measure of extreme sentiment.

Recall, when bearish sentiment becomes extreme, that is when it is useful to look for a major turn and spring a bear trap.

So let’s see how the hedge funds are positioned in the futures market.  This is COT as of Oct 4:

For weeks, hedgies have been bearish and now hold about 3:1 short bets.  That is pretty lopsided. And during the week ending Oct 4, they went even more bearish.  That was because they are trend-followers and there was a well-developed trend in place then.

Here is the chart showing that trend into Oct 4

The market was in hard down mode which culminated at the Hard Brexit plunge of last Friday.  Incidentally, with that huge loss, will it be called ‘Black Friday’ to add to all the other Black days our sterling currency has endured over the years?

Also incidentally, today I spotted this in the Telegraph: “From $5 to $1.22: The 200-year journey of the pound against the dollar” which is a nice review of cable’s progress.  But note the bearish tone to the interviews – totally in keeping with the overall bearish mood.

When I was young, the rate was £1 = $4 and that made a dollar worth five shillings and a half-a-crown ( a very common coin) was referred to as ‘half a dollar’.

I have seen several extreme predictions of parity surfacing as well – and putting it all together, I sense that bearish sentiment must be at or very close to an extreme.  And hence a short term bottom.

But what do the charts say?

This is the 1-hour chart showing the plunge and recovery which has traveled in the trading channel between my very pretty tramlines.  Note the accurate two touch points on the lower tramline and the accurate ones on the upper.  There is a small mom div building that could lead to a rally – provided the market can break up past the upper tramline (resistance) into the pink zone.

If that occurs, that would sent some hedgies running for cover.

But I wonder what could possibly produce a vigorous rally from here? What could set the shorts running for cover?  Could it possibly be the media have the Hard Brexit story all wrong?

We know that politicians are experts at talking out of both sides of their mouths at the same time, and it is not outside the bounds of possibility that news will emerge of a softening in the UK government stance on Brexit ‘negotiations’.  Hmm.

Watch this space.

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