Stock  markets  and  currencies  are  they  correlated?    

By  Equitimax  founder  Allan  Foulkes  

Stock  markets  are  one  of  the  barometers  of  a  healthy  or  unhealthy  economy  and  as  many  traders,  investors  and  individuals  watch  the  markets  they  tend  to  buy  into  the  idea  that  they  all  go  up  together  and  go  down  together,  this  is  not  true.  

Movements  in  the  general  indices  like  the  S&P  500,  the  NASDAQ  and  the  FTSE  100  are  the  general  litmus  reading  for  the  whole  market  in  each  country:    

Note:  Sometimes  the  larger  companies  are  flat  and  the  smaller  companies  or  mid  cap  stocks  can  be  booming,  take  that  view  though  and  put  it  to  one  side  and  look  at  the  major  indices  as  the  real  sentiment  and  real  measure  of  a  market.  

Most  of  the  markets  capitalisation  (market  value)  is  represented  by  the  largest  listed  companies  and  so  the  indices  represent  the  general  market  sentiment.  

If  the  markets  are  rising  and  the  FTSE  for  example  is  rising  does  this  mean  that  the  GBP/USD  will  rise  accordingly,  can  we  expect  to  see  a  similar  performance,  are  these  two  huge  financial  instruments  correlated?  

If  the  markets  are  rising,  then  investors,  traders,  speculators  and  the  huge  funds  that  trade  the  largest  portion  of  the  market  should  be  able  to  anticipate  market  movements  from  other  financial  instruments.    

 

Clearly  we  can  see  here  that  at  times  these  two  huge  markets  move  in  different  directions  and  seem  to  have  a  low  correlation  between  them.  This  is  interesting  because  this  means  that  if  the  markets  are  struggling  does  FX  trading  provide  a  different  result?  

The  real  difference  is  the  investor  mentality  and  the  trading  mentality  of  the  two  different  markets.  

Investors  who  buy  the  shares  of  the  large  companies  that  make  up  the  FTSE  100,  hold  these  investments  and  continue  to  buy  when  prices  fall  and  try  to  sell  when  they  rise  again.  This  is  an  investors  mentality  buy  low  sell  high,  like  you  would  with  a  house.  

Equitimax  traders  constantly  take  all  this  into  consideration  when  managing  the  accounts  of  investors.  

Here  are  the  correlations  in  FX  markets  based  on  the  direction  of  the  stock  markets  and  it  makes  interesting  reading.  

 

 

The  difference  in  trading  the  FX  markets  is  that  the  longer  term  investor  type  financial  models  are  not  used  as  much  as  the  strategies  are  basically  to  try  to  find  a  trend  and  trade  it  up  or  try  to  pick  the  top  and  bottom,  as  this  adds  more  value,  if  you  get  it  right.  

Currency  strategies  tend  to  be  about  buying  long  and  selling  short,  when  the  signs  are  right  and  closing  the  trades  out  and  collecting  the  profits  which  will  build  equity  and  increases  the  size  of  the  trading  account.  

Summary  

The  Illustration  below  highlights  that  certain  markets  are  not  correlated.  

 

If  you  are  using  shorter  term  trading  systems  around  the  FX  markets  the  overall  direction  and  the  sentiment  of  the  world  stock  markets  and  indices  has  little  impact,  there  are  ways  around  trading  a  falling  and  a  rising  market  and  as  the  illustration  above  highlights,  the  markets  are  not  completely  correlated.    

This  is  the  reality  of  the  financial  markets  which  will  provide  excellent  opportunities  in  the  FX  markets  irrelevant  of  the  investor  driven  stock  markets.  

Some  markets  like  the  USD  based  FX  currencies  provide  a  stable  place  for  funds  when  markets  are  bad  yet  funds  flow  out  of  these  markets  when  things  are  perceived  to  be  good  as  investors  are  prepared  to  take  more  risk  in  countries  like  Australia,  New  Zealand  and  Canada  who  typically  have  higher  interest  rates.  

 

 

 

Stock market movements are watched by casual investors to active traders. Many times, the movements of the stock markets can give clues about potential movements in currency trading. Below is a table of general tendencies that a trader familiar with stock trading can use to guide them in forex trades. If the stock market is said to be in a “risk on” mode with prices on the rise, then you tend to see these currencies below trade in noted general directions.

For example, if the stock market moves higher, you tend to see the AUDUSD move higher as investors seek risky assets. Risky assets include the stock market and higher yielding currencies which currently are the AUD and NZD. At the same time, as investors seek out ‘risky’ assets, currency pairs like the EURAUD and GBPAUD tend to fall as traders look to earn the large daily dividend those pairs offer. This is known as a Carry Trade Strategy. [Watch this short video on the carry trade strategy.] On the other hand, if traders are in a ‘risk off’ mode and are averse to risk, the opposite of these relationships tend to occur.

For example, if the stock market is in a downtrend, then a currency pair such as the USDCAD tends to move higher as traders buy the USD for its safe haven status. Regardless of the movement of the stock market, there generally exists a currency which you can buy. Now, the key is identifying a high probability area to time an entry in the trade. Use levels of support and resistance to identify these key areas with the help of oscillators to indicate momentum. *Keep in mind correlations move into and out of favor with one another. Therefore, a price of one instrument is not always going to move tick for tick with the other related instrument.  

To  find  out  more  about  the  stock  markets  and  currencies  visit  Equitimax  at  www.equitimax.com