By Chris Igou, analyst, True Wealth
If we’ve been reminded of one thing during this crisis, it’s this…
“King Dollar” still reigns supreme.
Demand for the buck soared during the worst days in the stock market, and the dollar has risen in value as a result.
Of course, when the dollar rises, other currencies fall. One victim is a currency that has taken repeated beatings in recent years… the British pound.
The pound recently fell to a 25-year low. But don’t let that fool you… This isn’t a buy signal. History says more losses are likely.
Let me explain…
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“Markets can stay irrational longer than you can stay solvent…”
It’s an old stock market cliché. You hear it a lot in the financial world. But that’s because this happens in the market over and over again… The trend usually lasts far longer than folks expect.
First, investors buy up an asset on the cheap after a big fall. They buy thinking they’re getting a great deal.
Then, it falls further… and further… And just when they think it can’t fall even more, it falls again.
What recently happened to the British pound is a great example.
The pound tanked after the United Kingdom voted to leave the European Union in 2016. The U.K.’s currency hit its cheapest level relative to the dollar in years. And to some folks, it looked like a great value.
But fast-forward to today, and the pound has just gotten cheaper. It hit its lowest level since 1985 just last week. Take a look…
The currency broke below both its 2017 and 2019 lows last week. But again, this isn’t a buy signal…
New 52-week lows like we just saw in the pound tell us one thing – that the downtrend is entering another phase of its drop.
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This isn’t a “buy the dip” indicator. Instead, it’s a warning sign that tells us more losses are likely from here. So while the pound just hit a multidecade low, it still has room to fall further.
Since 1980, similar 52-week lows have led to losses over the next six months. You can see this in the table below…
Remember, currencies are supposed to hold their value over time. So it’s no surprise these numbers are small. What’s important is the sheer underperformance after situations like this one.
Since 1980, similar cases drove the British pound down 1% over three months… And they have led to a 2% drop over a typical six-month period.
That’s more than double the losses you’d suffer using a buy-and-hold strategy. And it tells us that “buying the dip” would be foolish in this case.
If you’re looking to buy the British pound at an incredible discount, history says you’re better off waiting until the trend turns.
King Dollar continues to reign supreme. And that means more downside is likely in the British pound.