Share:

Each day the global financial markets are impacted by events that cause traders to react in dramatic fashion.  These responses quite often will have a ripple effect that can stretch across all types of markets and asset classes.  In other words, what happens in one market will in turn move another related market. For newer traders, it’s important to understand this relationship. In this post, I’ll go over some of the strongest inverse market correlations and their uses to help traders gain an edge.

But before we get started, there is one major caveat about this topic: correlations usually hold, however, there are times when what seemed to be a strong correlation between two markets breaks and no longer works. This is often a temporary phenomenon as strong correlations always revert back. An astute trader must be attuned to these changes and be flexible enough to make the adjustments necessary to keep his edge.

The first inverse correlation we’ll go over is the one between stocks and bonds.  For stocks, we’ll use the ES (S&P 500 mini) against the (US) 30-year treasury bond futures contract to do the analysis.  This is a simple risk-on versus risk-off correlation.  What is meant by this is that theoretically, stocks are inherently riskier than bonds and therefore when stocks are moving higher investors generally have a bigger appetite for risk and would sell the lower yielding bond market. This changes however, when things get rough in the stock market.  Investors seek the safe harbor of treasuries, and in order to raise the cash necessary to purchase these fixed yielding instruments, they sell their stock holdings.  The two annotated charts below illustrate these inverse correlations.

Lessons from the Pros - Futures

SP

We can see that major inverse moves happened pretty regularly in these two asset classes. The key for traders is to find both markets entering opposing levels simultaneously, thus increasing the probabilities of timing the turning points.  This correlation is important for traders who engage the markets on an intermediate-term time frame as it can be a major odds enhancer. Identifying the quality supply and demand levels is the most important element of this equation.

The other inverse correlation we’ll look at is that of the US Dollar index against the Euro Currency.  This is a very strong inverse correlation because of how the Dollar Index is comprised, and the way the currency futures contracts are traded.  First, the Dollar index is a basket of currencies traded against the US Dollar. The biggest component of this index is the Euro currency constituting over 57% of the index. In addition, currency futures are only the major global currencies (major industrialized countries) relative to the US dollar. In other words, they track the exchange rates of two currencies; because of this, the moves in the Euro currency greatly impacts the Dollar index.  Similar to the Stock-Bond inverse correlation, we can see on the charts below that all the major moves happened on the same day.

ECM

DXY

For traders trying to gain an edge, learning how different markets impact one another is a must.  Not knowing how the US Dollar can change the trajectory of commodities such as oil, copper or gold is a big disadvantage, especially when you’re competing with large banks and institutions who wouldn’t think of putting their traders on the front lines if they didn’t understand how the markets impact one another. If you want to have a chance to compete successfully you need to start thinking and acting like them; and one part of that is gaining an understanding of the interrelationships between markets. For the novice trader having a basic understanding of these two correlations is a good starting point.

Until next time, I hope everyone has a great week.

Learn to Trade Now

This content is intended to provide educational information only. This information should not be construed as individual or customized legal, tax, financial or investment services. As each individual's situation is unique, a qualified professional should be consulted before making legal, tax, financial and investment decisions. The educational information provided in this article does not comprise any course or a part of any course that may be used as an educational credit for any certification purpose and will not prepare any User to be accredited for any licenses in any industry and will not prepare any User to get a job. Reproduced by permission from OTAcademy.com click here for Terms of Use: https://www.otacademy.com/about/terms

Editors’ Picks

EUR/USD fluctuates in daily range above 1.0600

EUR/USD fluctuates in daily range above 1.0600

EUR/USD struggles to gather directional momentum and continues to fluctuate above 1.0600 on Tuesday. The modest improvement seen in risk mood limits the US Dollar's gains as investors await Fed Chairman Jerome Powell's speech.

EUR/USD News

GBP/USD stabilizes near 1.2450 ahead of Powell speech

GBP/USD stabilizes near 1.2450 ahead of Powell speech

GBP/USD holds steady at around 1.2450 after recovering from the multi-month low it touched near 1.2400 in the European morning. The USD struggles to gather strength after disappointing housing data. Market focus shifts to Fed Chairman Powell's appearance.

GBP/USD News

Japanese Yen bears turn cautious amid intervention fears and geopolitical tensions

Japanese Yen bears turn cautious amid intervention fears and geopolitical tensions

The Japanese Yen remains depressed near a multi-decade low amid the BoJ’s dovish outlook. Reduced Fed rate cut bets lift the USD to a fresh YTD top and further lend support to USD/JPY. Intervention fears and a softer risk tone could help limit deeper losses for the safe-haven JPY.

USD/JPY News

Editors’ Picks

EUR/USD fluctuates in daily range above 1.0600

EUR/USD fluctuates in daily range above 1.0600

EUR/USD struggles to gather directional momentum and continues to fluctuate above 1.0600 on Tuesday. The modest improvement seen in risk mood limits the US Dollar's gains as investors await Fed Chairman Jerome Powell's speech.

EUR/USD News

GBP/USD stabilizes near 1.2450 ahead of Powell speech

GBP/USD stabilizes near 1.2450 ahead of Powell speech

GBP/USD holds steady at around 1.2450 after recovering from the multi-month low it touched near 1.2400 in the European morning. The USD struggles to gather strength after disappointing housing data. Market focus shifts to Fed Chairman Powell's appearance.

GBP/USD News

Gold aiming to re-conquer the $2,400 level

Gold aiming to re-conquer the $2,400 level

Gold stages a correction on Tuesday and fluctuates in negative territory near $2,370 following Monday's upsurge. The benchmark 10-year US Treasury bond yield continues to push higher above 4.6% and makes it difficult for XAU/USD to gain traction.

Gold News

XRP struggles below $0.50 resistance as SEC vs. Ripple lawsuit likely to enter final pretrial conference

XRP struggles below $0.50 resistance as SEC vs. Ripple lawsuit likely to enter final pretrial conference

XRP is struggling with resistance at $0.50 as Ripple and the US Securities and Exchange Commission (SEC) are gearing up for the final pretrial conference on Tuesday at a New York court. 

Read more

US outperformance continues

US outperformance continues

The economic divergence between the US and the rest of the world has become increasingly pronounced. The latest US inflation prints highlight that underlying inflation pressures seemingly remain stickier than in most other parts of the world.

Read more

RECOMMENDED LESSONS

7 Ways to Avoid Forex Scams

The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?

What Are the 10 Fatal Mistakes Traders Make

Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.

Strategy

Money Management

Psychology