Different forex and stock themes appearing despite high level of correlation
These two charts show that despite high levels of positive correlation in a kind of ‘risk-on, risk-off’ mode in both forex majors and stock indices, we can make out different levels of performance or themes.
Chart #1 – USD versus major currencies, daily timeframe, year to date
In this chart, we see pairs overlaid to show USD performance against favourite currencies. Peaks and troughs coincide very well demonstrating how they go ‘risk-on, risk-off’ together. However there is room for outperformance if a forex trader picks the right pair.
Look for these if current trend persists:
- USDCAD outperforms, CAD is weakest.
- USDJPY is a loser, JPY strongest.
- In the middle GBP, EUR, CNH and SGD are bunched together.
What traders can do
- USD bulls can find best performance by going long USDCAD.
- USD bears can find the best bang going short USDJPY.
- Traders who want to skip the USD could look at crosses consisting of currencies at the two ends i.e. short CADJPY, AUDJPY or long NZDCAD.
- Note that trading pairs that are adjacent to each other might offer little performance e.g. EURGBP.
- Also trading two or more pairs in the centre concurrently such as EURGBP and NZDCNH should offer little diversification.
Chart #2 – Stock indices (CFDs) overlaid, daily time frame, YTD
This chart shows that there was a high level of positive correlation in January apart from a weaker UK100 (FTSE). In February, all of them corrected steeply and then appear to find bottom at the same time.
However subsequent performance should reveal who the real winners and losers are – like when the tide goes out, we know who was swimming naked.
We can probably describe this chart as:
- At the two ends, NAS100 (Nasdaq100) is the clear winner and UK100 the loser.
- Apart from CN50 (China A50) that is sitting close to breakeven, there are now two camps.
- The losing trio are DE30 (DAX), JP225 (Nikkei) and UK100.
- NAS100 appears to be in a class of its own.
- Holding index positions in SPX500 (S&P500), HK33 (Hang Seng), SG30 (SiMSCI) and US30 (DJ30) concurrently should offer little outperformance/diversification since they are tracking each other closely.
What traders can do
- Stock market bulls should consider NAS100.
- Stock market bears should keep an eye on UK100, JP225.
- Taking a hedge fund strategy, traders could concurrently long NAS100 while and short UK100. This might offer protection from volatility and could even be an outperforming strategy over time.
Relative strength overlays are explained in greater detail here and here. Also in this post, I share my reasons why I see such overlays as a nuts and bolts approach to get a complete, accurate picture of the market.