By Jay Meisler
Algos and other programmed trading are always on the lookout for correlation trades that are working and continue with them until they stop working. One correlation that has stood the test of time is forex-equities although the degree of which varies depending on the current situation. As a forex trader, I have found that the direction in equities is more important than the tic-by-tic correlation although there are days when it can be very tight, making the forex market trade like a house of cards. What I mean by this is that forex moves can be cut short and reversed during times of high volatility by movements in the equity market. Equity traders may say it is forex that leads but we find it is the other way more often than not.
As the charts below show, the correlation was very tight today. EURUSD, which was driven higher on Monday into Tuesday as the S&P extended its sharp losses in early trading, fell like a house of cards collapsing as stocks turned around. The strength of the EUR is attributed to carry trades being unwound when equities get liquidated. Whether this is still going on is subject to conjecture but as long as the correlation is working, the market will continue to trade it.
S & P (CFD) 5 Minute Chart
EURUSD 5 Minute Chart
In any case, you can see by the charts what happened to the EURUSD, which had been bid up overnight by a risk off mood as seen by weaker equities before folding up like a cheap suit (i.e. it retreated from a 1.1281 high to a low at 1.1194 before a bounce as equities gave back modest gains). The point is when correlations are tight, you need to keep an eye on the direction of the market that is leading to avoid seeing what may have looked like a safe position collapse like a house of cards.
Addendum: September 30, 2015 11:30 GMT: Equities have rallied sharply overnight. This has seen correlations kick in to push the EUR and JPY lower, both vs. the dollar and on key crosses, as of this writing as markets trade with a risk-on mood.
Jay Meisler, founder