Demystifying the GBP/USD Currency Pair: Forex Trading

The GBP/USD currency pair, commonly known as "Cable", serves as a key metric for measuring the relative values of the British pound to the US dollar. Renowned for its liquidity, this pair stands out as one of the most sought-after assets in the global forex trading landscape.

When it comes to currency trading, the British pound versus dollar market is one of the most widely favored among investors. Beyond its forex significance, it reveals insights into the economic relationship between the UK and the US.

In this article, we'll explore GBP/USD basics, historical trends, factors influencing the movement of GBP/USD, and practical ways to trade GBP/USD.

GBP/USD Currency Pair Basics

The GBP/USD currency pair is the abbreviation used in forex trading to refer to the Great British pound (£) and United States dollar ($) currency pair. This is the world’s oldest trading currency pair, sometimes called “Cable” since early trades were transmitted between London and New York via telegram cable.

Just like the EUR/USD (Euro and US dollar) and USD/JPY (USD and Japanese yen), the GBP/USD is often considered one of the most traded currency pairs. In pairs, the stronger currency is listed first. Then the value of the pair is given as how many of the second currency you need to buy one unit of the first. For example, a forex GBP/USD currency rate of 1.27 means it costs $1.27 to buy £1. Basically, the rate is a formula for converting pounds to dollars.

Moreover, trading the pound-dollar pair is popular within the forex market because it’s one of the highest-volume and most liquid currency pairs. Consequently, it’s among forex’s “major currency pairs," which means that it retains its importance on the market even when trading stagnates and it becomes a lower-performing currency.

All the majors include the US dollar since the United States is the largest economy in the world. The British economy is the fifth largest and also historically important due to factors such as the British Empire and colonies.

GBP/USD Exchange Rate History

Exchange rate trends between the British pound and the US dollar have changed markedly over the last 100 years. In GBP/USD history, the pound initially dominated. In the 1800s, the pound was worth about 5 US dollars. This rose to 10 USD during the American Civil War.

In the early 20th century, before the outbreak of the First World War, the British pound was the dominant international exchange currency.

Following the war, the pound started declining in value while the US economy grew. After World War II, the Bretton Woods Agreement was signed, establishing the US dollar as the global primary reserve currency pegged to gold. Many other currencies, including the pound, were then pegged to the US dollar. In 1944, £1 was worth 4.03 USD.

This pegging ended in 1971 when President Nixon ended the gold standard and currencies began to float freely in the market. This resulted in more volatility in the GBP/USD exchange rate, which was now influenced by political and economic factors in both countries.

The strength of the US economy meant that between the 1970s and early 2000s, the value of the dollar fluctuated between 2-2.65 USD per pound. But this changed with the 2008 recession, which saw the dollar value of the pound falling to $1.4, as people flocked to buy dollars as a safe currency. The exchange rate would stabilize at around 1.6 USD.

The pound's value fell again with the announcement of Brexit in 2016 and the expected financial fallout of Britain leaving the European Union. It fell yet again in September 2022 to an all-time low of 1.03 USD due to disastrous financial policies announced by then-Prime Minister Liz Truss. The rate has now stabilized at around 1.28 USD. Nevertheless, this represents a major shift in the history of pound vs dollar exchange rate.

Factors Influencing GBP/USD Trends

While historical exchange rates offer insights into influencing events, understanding the factors currently affecting GBP/USD is vital for predicting its movements. Forex traders observe the following to understand likely GDP/USD movement:

Economic Indicators: Economic data, including GDP growth, unemployment rates, retail sales, and inflation, play a crucial role. Higher inflation in the UK, for example, could lead to a weaker pound against the dollar.

Monetary Policies: Decisions by central banks like the Bank of England (BoE) and the Federal Reserve (Fed) are significant. A BoE interest rate hike when the Fed doesn't follow suit could strengthen the pound.

Political Events: Events like Brexit, elections, government changes, conflicts, and trade agreements could impact currency values.

Market Sentiment: Similar to stocks, market perception influences currency values. During the 2008 global recession, the US dollar gained strength as a perceived safe-haven currency.

GBP/USD's close connection to economic factors, including interest rates, inflation, and more, means that the currency pair can also provide insights that can be used to gauge economic health and predict changes in economic performance.

How To Trade GBP/USD

Forex is the largest trading market globally, with the 2019 Triennial Central Bank Survey reporting a daily trading volume exceeding $6.6 trillion. The popularity of the forex market, which is open 24 hours a day, five days a week, is due to its high volume, liquidity, and accessibility.

Forex trading is essentially the buying and selling of currencies. As with stocks, the idea is to buy currencies when they’re cheap and expected to increase in value, then sell when currency values are high but expected to drop.

You can make your trades with a Forex broker. When trading GBP/USD, the broker will give you a bid price and an ask price. The bid price is what you will receive if you sell a pair, and the ask price is what you need to pay to buy a pair.

Pips in Forex

Due to market factors, bid and ask prices are not equal. The difference between them is called the spread, and the spread is measured in pips. A pip is the smallest unit of price change for a currency pair, equal to 0.0001 of the quoted currency. For example, if the bid price is 1.31346 and the ask price is 1.31354, the spread is 0.00008, which would be 0.8 pips.

If you buy a currency when the spread is at 0.8 pips, and this increases to 2 pips while you’re holding the currency, then you have a gain. If it decreases to 0.4 pips while holding the currency, you have a loss.

Approaches to Trading GBP/USD: Spot vs CFD

There are two main ways to trade on the forex market, spot trading and contract for difference (CFD) trading.

Spot Trading

Spot trading involves real-time buying and selling based on current exchange rates. Your trades are made “on the spot.” These are real currency trades where the buyer takes possession of the currency asset, as opposed to futures or forward contracts. It’s suitable for those who can react to immediate market influences.

CFD Forex Trading (Contract for Difference)

A CFD, or Contract for Difference, involves speculating on the price difference of a currency over time rather than physically purchasing it. This means traders can speculate on the price movement of the currency pairs without actually owning the assets.

When you initiate a CFD trade with a broker, such as Plus500, you commit to exchanging the price difference between the moment you open your position and when you decide to close it. You can choose to take a long position, indicating your belief that the currency will strengthen, or a short position, indicating your anticipation of the currency weakening.

Another important difference is that CFD trades use leverage, which allows traders to gain exposure to a larger value of trade with a relatively small amount of capital. When trading using leverage, you only need to put down a fraction of the total value of your position. Profits and losses are based on the total size of the position, so the end result of a trade can be much larger than the initial outlay in terms of profits or losses. The amount needed to open and maintain a leveraged trade is called the margin.

What Might an Example CFD Transaction Look Like?

If the GBP/USD rate is 1.3, and an investor expects the pound to strengthen, they can use a leverage of 10:1 to open a £10,000 contract, for which the margin is £1,000. If the rate rises to 1.31, they can close the contract for £10,100, making £100 in profit. Therefore, if the price of the underlying asset of the trade (£10,000) changes, for example by 1%, the price of the CFD itself has changed by 10%, amplifying potential profits and losses.

Find out more about Forex CFDs in our article: "Forex CFDs Explained."

GBP/USD Trading Strategies

Traders employ various strategies when trading GBP/USD, based on their preferences and risk tolerance. These strategies generally fall into two categories: macroeconomic analysis, which assesses market factors and predicts their impact, and technical analysis, which relies on statistical trends to forecast future movements.

The technical analysis extends beyond GBP/USD to consider related currency pairs with established correlations. For instance, GBP/USD generally exhibits a negative correlation with USD/CHF and a positive correlation with EUR/USD.

Within these broader trading strategies, specific approaches include:

• Day Trading: This involves multiple daily trades to profit from GBP/USD's constant rate fluctuations. Day traders must closely monitor market trends throughout the day.
• Swing Trading: As a strategy, swing trading capitalizes on upward or downward price trends in the market. Traders use technical analysis to identify optimal entry and exit points, making it suitable for highly liquid and volatile pairs like GBP/USD.
• Carry Trading: This leverages the different interest rates set by the central banks of different countries. Traders look for currency pairs where the currency being bought has a significantly higher interest rate than the currency being sold. Traders earn interest on the higher-yielding currency and pay interest on the lower-yielding currency.

Risk management is crucial in trading GBP/USD. Traders may employ tools like stop-loss orders to limit potential losses. This sets a specific price at which your trade will close automatically to limit your loss to a predetermined maximum. For instance, setting a stop-loss order at 1.1950 when entering a contract at GBP/USD 1.2789 allows a predefined maximum loss.

GBP/USD Trading Sessions

While forex markets are open 24 hours a day from Monday to Friday, there are different trading sessions throughout the day, during which different currencies are most active. This is largely based on time zone since big political announcements and economic swings tend to happen during the local work day.

The day is divided into three major trading sessions:

• European Session (London): 7 am to 4 pm GMT
• North American Session (New York): 12 pm to 8 pm GMT
• Asian Session (Tokyo): 11 pm to 8 am GMT

The European session, particularly when British and European economic data is released, is the most active and potentially volatile period for the pound. Additionally, the overlap between the European and North American markets from 12 pm to 4 pm GMT is known for its high activity and volatility, as it involves economic data releases from both the UK and the US.

This overlapping time may be considered an opportunity for trading due to the potential for significant price movements.

Understanding these session dynamics can help traders make informed decisions about when to engage in GBP/USD trading.

Mastering GBP/USD Trading Strategies and Risk Management

The GBP/USD currency pair offers a compelling opportunity for traders in the dynamic world of forex. Throughout this article, we've delved into the basics of GBP/USD, examining its historical context, the factors influencing its movements, and some practical strategies for trading it.

The factors influencing GBP/USD are multifaceted, encompassing economic indicators, central bank policies, political events, and market sentiment. These variables demand careful consideration when crafting trading strategies, emphasizing the importance of risk management and timely decision-making.

As you venture into the realm of GBP/USD trading, you'll find that understanding and managing risks are paramount to your success. Consider using Plus500's free risk management tools as a valuable resource in your trading arsenal.

FAQs for GBP/USD Trading

Is GBP/USD a good currency pair for trading?

GBP/USD is one of the most popular currency pairs for trading because of its high liquidity and volume, which provides opportunities for gain through short- and long-term trades.

What is the minimum amount I need to start trading GBP/USD?

You can begin trading GBP/USD in forex with as little as $10. Your potential gains are tied to your investment amount, with higher investments yielding greater profits but also higher losses.

Leverage allows you to trade higher amounts with less capital. For instance, with $1,000, you could open a $10,000 contract using leverage of 1:10, resulting in the potential for tenfold profits but also the possibility of tenfold losses.

How can I manage risks when trading GBP/USD?

There are a variety of strategies to minimize your risks when trading GBP/USD. One of the most effective is adding a stop-loss condition to a trade. This allows you to set the maximum amount you can lose before a trade is closed.

One British pound equals how many US dollars?

While the USD/GBP exchange rate is always fluctuating, GBP/USD FX rates have consistently been between 1.2 and 1.4 for the last five years.

How do I stay updated about news and developments that affect GBP/USD?

When you sign up with a CFD broker platform such as Plus500, you can access tools that allow you to stay up to date with what the market is doing. You can also follow financial news websites and join online forums specializing in forex updates.

What risks are involved in trading GBP/USD, and how do I manage them?

The biggest risk with forex trading is market volatility. It means that your investment can increase quickly, but it can also decrease. To protect yourself, never trade more than you can afford to lose. You can also use tools such as stop-loss orders to limit how much money you can lose on any contract.