It’s said that markets always overreact, with prices rising or falling beyond defensible levels in bouts of irrational exuberance as traders trade for the sake of trading rather than offering or asking reasonable prices for their wares. Nowhere is this truism more telling than the forex trading market. When a currency pair initiates a trend, it will almost always travel further than anyone foresees, decimating historic highs and lows in the process, and as a result forex traders learn to expect it all, and trade it, too.

True to the personality theory, different currency pairs overreact in different ways. Well-behaved pairs such as AUD/NZD and USD/CHF overreact by spiking through established support and resistance levels prior to turning, while the somewhat more volatile USD/CAD and AUS/USD actually push through and close a candle or two beyond support before belatedly turning. At the other end of the spectrum, strong-willed GBP/USD punches through support as if aiming at the protective stops clustered on the far side, determined to take them out before even admitting the level exists.

Market overreactions are also influenced by volume and liquidity. When traders are thin on the ground, currency pairs exhibit exaggerated movements, such as many showed over the recent holidays, or as is commonly seen at the end of August or the fiscal year. At such times, typical market overreactions become even more exaggerated than usual and currency pairs rise and fall to truly jaw-dropping levels.

Such has been the case recently with EUR/GBP.

On 12 November, EUR/GBP pushed above the upper resistance level of its established trading range at 0.8185, mainly on fundamental data showing the U.K. economy was being hit harder by the global recession than that of the Eurozone and therefore the BoE was likely to slash interest rates more quickly than the ECB. Although the currency pair spiked as high as 0.8662 that day, it quickly settled into a new trading range with resistance at 0.8605, and dealer chatter wondered if that would be that.

But the pattern began again on 4 December as the price spiked and closed above 0.8605. With many major institutional traders shutting down for the year to close their books and prepare for tax season, volumes fell and liquidity thinned, and irrational exuberance took hold amongst those traders remaining. Between 9 and 18 December, the pair set new historic highs each day, then briefly consolidated before shooting even higher on 26, 29, and 30 December, finally achieving a new record at 0.9802—1200 pips gained in less than a month, 1600 in six weeks. It has since fallen back to 0.9061 as of this writing.

Interestingly, that’s the 50% level on a Fibonacci retracement drawn from 28 November’s low of 0.8244 to 30 December’s high of 0.9802, best seen on daily charts. Although it’s certainly possible the exuberance could become even more irrational and the price could regain those lofty heights, on the basis of the fundamental data it seems more likely this is a classical market overreaction and that EUR/GBP is more likely to settle into a new trading range with the resumption of normal liquidity levels.

But it was a great ride while it lasted.