The Brexit Effect on Financial Markets and How You Can Exploit it 

 August 4, 2016

By  Advanced Strategies

On June 23 2016, the British citizens were asked to vote in a referendum on whether to continue remaining as a member of the EU or whether to cancel its membership, in effect to part ways with the EU. While many expected that the UK would vote to stay in the EU, the world and the financial markets were surprised after the UK shockingly voted to leave the EU. The term Brexit, resulted in a short span of market volatility with global indices falling sharply as a result. The Brexit Effect on Financial Markets is far reaching and does not just affect markets in UK but certainly will affect the US and even Asian markets.

So what is Brexit, why did the UK vote to leave the EU and more importantly, what to expect in a post-Brexit world? The answers to these questions are outlined in this article.

What is Brexit?

The term, Brexit was coined by Peter Wilding in May 2012, writing a blog post at Blogactiv.eu and refers to the UK’s referendum on EU membership. The referendum vote gained attention when the incumbent Prime Minister, David Cameron promised the UK citizens to vote in the referendum on whether they want to remain or part ways with the EU membership. This was because of increasing friction between the EU leadership in Brussels and 10 Downing Street. The Eurozone was also at the height of its financial and geo-political crisis with the world markets focused on Grexit. As part of his promises, Mr. Cameron promised voters that he would hold a referendum if he was elected for a second term, in January 2013. In his speech, Mr. Cameron said, “It is time for the British people to have their say. It is time to settle this European question in British politics. I say to the British people: this will be your decision.” (Source: BBC). He said that he would hold a referendum before 2017.

Following his poll promises, Mr. Cameron won a second term to head the UK as the Prime Minister and was quick to start negotiations with EU leaders to get better terms in areas of trade and most importantly immigration. In February 2016, after negotiating a deal with Brussels, PM Cameron returned to the UK and announced that the EU referendum vote would be held on 23 June, 2016.

The Brexit Effect on Financial Markets and How You Can Exploit it

However, many opponents to the EU membership were quick to announce their support for the UK to leave the EU. On February 21st, the then London mayor, Boris Johnson announced that he would back a Brexit (or a decision to leave the EU). Considered a big player in UK politics, the markets instantly fell after opening on Monday. The British pound fell over 2.67% in a span of just 5 days after Johnson’s comments.

Pre Brexit Effect on British Pounds in late Feb 2016
Pre Brexit Effect on British Pounds in late Feb 2016

After the preliminary fall in GBPUSD, by early March, the referendum campaigning started to pick up steam. The In and Out camps (those supporting the UK to remain in the EU vs. those supporting the UK to leave the EU) started their campaigns while opinion polls started to dictate the short term direction in GBPUSD.

On June 24, the Brexit polls were announced and the world woke up to the UK deciding to leave the EU membership. GBPUSD fell over 11% on the news. The global markets also fell strongly after the decision.

GBPUSD falls over 11% after UK votes ‘Out’ in the EU referendum
GBPUSD falls over 11% after UK votes ‘Out’ in the EU referendum

The Brexit Effect on Financial Markets

Although the markets were initially ‘very’ concerned on the UK referendum vote and many experts and finance ministers giving dire warnings, the after effects of Brexit was fairly limited on the global markets. Following the few days of strong losses, the equity markets managed to reverse and continued on their bullish rally. The FTSE100 for example fell over 5.30% on the day but soon managed to recover from the Brexit lows and managed to rally higher.

The Brexit Effect on Financial Markets
The Brexit Effect on Financial Markets

While the effect of Brexit was fairly contained on a global level, the UK markets were however not quite insulated. Following the verdict, businesses in the UK started to feel the heat. For example, in July (one month after the Brexit vote) the manufacturing, construction and services PMI all fell below the 50-level, indicating a contraction in the economy. According to latest reports, the UK is expected to enter a recession in the third quarter this year.

The Brexit Effect - UK PMI and GDP Comparison points to negative GDP growth in the near term
The Brexit Effect – UK PMI and GDP Comparison points to negative GDP growth in the near term

The Bank of England had already announced plans that it would cut interest rates after Brexit and possibly looking into expanding its monetary policy stimulus programs to offer a soft landing for the UK’s economy.

After the Brexit result, David Cameron resigned as the Prime Minister, giving way to Theresa May as the new PM who was quick to reshuffle the cabinet to form a team to steer the UK out of the EU.

What to expect in the future?

While the markets have shown a recovery after the Brexit, it is very likely that a new round of selling will take place, especially for the British pound. A weaker GBP is likely to push UK’s consumer prices higher which will compel the Bank of England to cut rates sooner than later and also expand its monetary policy programs. As a result, the GBP will likely continue to fall in the near term. This support from the BoE could however have a positive impact on the UK’s equity markets. The London FTSE100 is therefore very likely to continue to push higher supported by easy monetary policy.

You should also note that following the Brexit verdict, the UK has not yet invoked Article 50 of the EU Treaty. Negotiations are expected to continue with rough estimates pointing to a complete exit from the EU by 2018. While it is still too early to accurately state what the future might hold, expect to see some downside for the UK’s economy from here on with the third quarter likely to head into recession while the Bank of England will remain in a dovish mode.

How to Take Advantage of the Volatility from the Brexit Effect?

As we expect more volatility coming out from Brexit, the best approach to trading is probably on using breakout strategy. The are many indicators that you can use for breakout strategy. You can find plenty of strategies that we have outlined in this website. Have tight stops and predetermined entry and exit levels. It’s going to be a wild ride and it’s gonna be awesome!

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