Correlation between FX and Equities! (Chicken or the Egg?)
Which came first, the chicken or the egg?
Traders all over the globe are constantly looking for an edge, something that's going to give them an extra indication on market directional movements prior to them unfolding. I know from personal experiences and from chatting people at the firm that many traders lean towards finding correlation between the equities market and the FX market. There are a lot of analysts out there that say the equities market is what moves the FX market, and in return there are a lot of people that say the FX market is what moves the equities market.
So, which one is it?
Reality is will never know. There have been many of times where the FX market and shows clear indication of direction and then about a day later or a few hours later we have the equities follow suit. For example the RBA's recent decision to hike interest rates by .25% instead of 0.5% sent the Aussie dollar down, but when you move over to the AUS200 or look at General Equities in the ASX, you'll see that they had their biggest day in 2.5 years.
Then there are times, and this is more into day trading, where the indices in the equities movements tend to correlate well moving into the FX markets.
So there is evidence to support both sides. Not ideal.
It goes without saying that correlation between equities and FX is slowly starting to fade as volumes kick up since we are in the technologically advanced era. But, what is or was the correlation and how does it work?
The basic theory (aged) is that when equity markets rise, confidence in that specific country grows well, leading to an inflow of funds from foreign investors. Therefore, equities go up, FX value goes up. It's simple supply and demand when you look at it. If the equities are going up and you're a foreign investor and you want to buy into those equities, it creates demand for holding, let's say, the US dollar if I wanted to buy into the S&P 500.
On the flip side, when the equity markets are falling. Then confidence falters, causing investors to convert their invested funds back to their own currencies outside of that country.
This is a general theory and I don't recommend basing any of your trading decisions on this, because if you actually have a look at the charts and the correlation, you'll notice that recently it's not been too hot. While you do get a general directional bias, one tends to move before the other and they tend to be quite random in which one goes first. If you have the ability or the skill to be able to work out when something is correlating and when something isn't, then for sure I think you'll be able to find an edge in the market trading some kind of correlation between equities and FX.
One correlation I have seen to be quiet useful in recent times is the S&P 500 And the Nikkei. Although in the Asian session the Nikkei is open in the S&P 500 isn't. Usually you see the S&P move and the Nikkei follow suit. Keep an eye on that correlation and tell me if you find any patterns.
As a whole, trading correlations can give you an edge in the market. It can provide you with valuable information when it comes to trading, whether you are trading FX or trading Equities. But it's not as simple as it seems. It will take more diving and understanding the markets on a deeper level to know when their correlating and to know when to ignore.
I hope you guys have enjoyed this article. If so, please give us a like leave and a comment. It does help the post a fair bit and I'll see you next week for some more content. Happy Trading!
-Jordon Mellor
Traders all over the globe are constantly looking for an edge, something that's going to give them an extra indication on market directional movements prior to them unfolding. I know from personal experiences and from chatting people at the firm that many traders lean towards finding correlation between the equities market and the FX market. There are a lot of analysts out there that say the equities market is what moves the FX market, and in return there are a lot of people that say the FX market is what moves the equities market.
So, which one is it?
Reality is will never know. There have been many of times where the FX market and shows clear indication of direction and then about a day later or a few hours later we have the equities follow suit. For example the RBA's recent decision to hike interest rates by .25% instead of 0.5% sent the Aussie dollar down, but when you move over to the AUS200 or look at General Equities in the ASX, you'll see that they had their biggest day in 2.5 years.
Then there are times, and this is more into day trading, where the indices in the equities movements tend to correlate well moving into the FX markets.
So there is evidence to support both sides. Not ideal.
It goes without saying that correlation between equities and FX is slowly starting to fade as volumes kick up since we are in the technologically advanced era. But, what is or was the correlation and how does it work?
The basic theory (aged) is that when equity markets rise, confidence in that specific country grows well, leading to an inflow of funds from foreign investors. Therefore, equities go up, FX value goes up. It's simple supply and demand when you look at it. If the equities are going up and you're a foreign investor and you want to buy into those equities, it creates demand for holding, let's say, the US dollar if I wanted to buy into the S&P 500.
On the flip side, when the equity markets are falling. Then confidence falters, causing investors to convert their invested funds back to their own currencies outside of that country.
This is a general theory and I don't recommend basing any of your trading decisions on this, because if you actually have a look at the charts and the correlation, you'll notice that recently it's not been too hot. While you do get a general directional bias, one tends to move before the other and they tend to be quite random in which one goes first. If you have the ability or the skill to be able to work out when something is correlating and when something isn't, then for sure I think you'll be able to find an edge in the market trading some kind of correlation between equities and FX.
One correlation I have seen to be quiet useful in recent times is the S&P 500 And the Nikkei. Although in the Asian session the Nikkei is open in the S&P 500 isn't. Usually you see the S&P move and the Nikkei follow suit. Keep an eye on that correlation and tell me if you find any patterns.
As a whole, trading correlations can give you an edge in the market. It can provide you with valuable information when it comes to trading, whether you are trading FX or trading Equities. But it's not as simple as it seems. It will take more diving and understanding the markets on a deeper level to know when their correlating and to know when to ignore.
I hope you guys have enjoyed this article. If so, please give us a like leave and a comment. It does help the post a fair bit and I'll see you next week for some more content. Happy Trading!
-Jordon Mellor
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