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Everyone's a Currency Trader Nowadays (Whether They Know it or Not)
Written by article default Tuesday, 22 June 2010 04:02
Since the outbreak of the sovereign debt crisis in Europe, the US stock market's center of attention has squarely been placed on the daily movements of the Euro currency; particularly, the dollar relationship between that currency. It's safe to say that the US equity markets are trading in lock-step with the Euro currency these days. The logic is simply a risk aversion play. Since the US Dollar is still perceived as the world's strongest paper currency, it is bid up (bought) when global markets are in disarray, as investors look for a safe haven.From a trader's perspective, it is important to identify these correlations early, and perhaps even more imperative to figure out when those relationships are broken.
There are several ways one can track the currency markets. The easiest way is to find quotes in the foreign exchange spot market known as "pairs." These are simply all the world currencies matched among one another in every conceivable pairing. One example – and the one most are watching closely - is the EUR/USD, which quotes the Euro versus the US dollar. Incidentally, you can find these quotes free throughout the web.
If you regularly read the Lesson from the Pros articles, you already get great insight on this subject matter from my fellow writer and excellent instructor Sam Evans, who is based in London. It seems that folks across the pond have a much better awareness and keen interest in the currency markets than we do here in the United States, and even more so recently, for the obvious reasons.
All the major global currencies are also expressed in futures contracts. The most important of these, and the one I follow, is the US Dollar index (DX), which trades on the Intercontinental Exchange (ICE). The US Dollar Index is a measure of the value of the US dollar versus six of the foremost global currencies, with more than half (57.6%) of its weighting in the Euro. The other five currencies in the basket are the Japanese Yen, British Pound, Canadian Dollar, Swedish Krona, and the Swiss franc - in respective order of weighting.
To illustrate this correlation, let's look at the two charts below. The first one is the ES (E-mini S&P), and the second is the aforementioned US dollar index.
Figure 1
Figure 2
We can clearly see that when the ES declines, the Dollar index rallies, and vice versa. Since the Eurozone is now the focal point, you could make the case that when sovereign debt worries erupt there, the descent of its currency (DX Rally) could in turn pressure US equities.
An example of this came earlier this month. Note June 3, which I've highlighted in yellow on both charts. If you look closely, you see the DX begin a sharp rally that day, while the S&P essentially meandered. The following day, however, the market suffered a steep sell-off, and of course, the dollar's upside momentum accelerated. Some of you may remember that was the day the disappointing jobs number was released.
To explore this on a technical basis, observe the lower chart. In it, we see the multi-week breakout of the US dollar index occurring right around 4:30 am PST, an hour prior to the release of the unemployment numbers. Technically, in my humble opinion, the die had been cast for weakness by the opening bell.
Figure 3
In summary: The US stock market and Euro currency are dancing the tango; when one zigs the other zags. It is important to monitor these relationships as perhaps they might provide an edge. It is anybody's guess when this link will break or what will be the cause, but for now, you need to play it accordingly. Sometime in the future when Europe's problems subside, I'm sure another theme will emerge. When it does, we'll have to identify it sooner than most, because by the time everyone figures it out, the edge will be gone.