Jump to content

Welcome to the new Traders Laboratory! Please bear with us as we finish the migration over the next few days. If you find any issues, want to leave feedback, get in touch with us, or offer suggestions please post to the Support forum here.

  • Welcome Guests

    Welcome. You are currently viewing the forum as a guest which does not give you access to all the great features at Traders Laboratory such as interacting with members, access to all forums, downloading attachments, and eligibility to win free giveaways. Registration is fast, simple and absolutely free. Create a FREE Traders Laboratory account here.

RichardCox

Correlations Between the Stock Market and Carry Trades

Recommended Posts

A common mistake made by many technical analysis traders is failing to watch the ways various assets interact and perform under different market conditions. Some assets show incredibly high correlations (moving in a similar fashion at similar times), while others are inversely correlated to a near-perfect degree. This information can be highly valuable for traders because the price behavior forecasts that are required to make successful trades can be tailored (at least in part) based on the activity that has already been seen in related assets.

 

Historically, one of the best examples of highly correlated assets can be found in the stock market and in the carry trade, which pairs high interest currencies with low interest currencies. The strategy requires traders to buy a high yielding currency, using a low yielding currency as the funding asset. In these trades, investors can gain the dual benefit of favorable currency moves and the interest that is captured for as long as the trade is held.

 

Common examples of carry trades include AUD/JPY and NZD/JPY but the currency pairs that are used in these cases will depend on the prevailing interest rate levels at the moment. The Japanese Yen has offered extremely low interest rates for a long period of time, and because of this, the JPY tends to be the “go-to currency” for those looking to position themselves using this trading method.

 

Asset Performance During Periods of Market Stability

 

Now that we understand how the carry trade works, it is important to understand which environments provide the best opportunities to make gains using this strategy. To do this,we can look at opposing market scenarios. In the first case, imagine that price activity is rapidly changing because of widespread economic uncertainty. A good example of this would be the 2008 Credit Crisis, or the 1999 tech bubble in stock markets. In these cases, price activity was highly volatile and this tends to be unfavorable environments for both stocks and carry trades.

 

A quick look at chart activity during these periods will show extreme bearish declines, as investors looked to pull their money out of riskier assets and find protections in safe havens. Now imagine a second scenario, where price volatility is more subdued, and market fundamentals are showing more stable and predictable data releases. Excellent examples of this could be seen during the market rallies of the 1990s and in 2007. In these cases, the general stability of the financial world allows investors to take on additional risk (in order to increase the chance of enhanced gains). During periods like this, both stock markets and carry trades tend to perform well.

 

Applying this Behavior to Trading

 

The use of technical analysis is essentially an expectation that what has happened in the past is likely to happen again in the future. With this in mind, trades can be taken based on the market environment that is currently in place and on the ways these different assets have performed with respect to one another. For example, stock markets are now approaching their highest levels in 5 years, which leads many traders to look at stocks as overbought and in danger of a downside reversal.

 

This trading bias can be applied to highly correlated currency pairs (such as the AUD/JPY), and major breaks of support will then be viewed by many as being more credible, creating a better chance of significant follow-through. Hypothetically, the opposite scenario (a large scale bear market in stocks) would be viewed by many as a buying opportunity in currencies like the AUD/JPY if upside breaks of resistance were seen. This bullish bias would be based on the idea that a heavily correlated asset (the stock market) is oversold and is ready for an upside correction.

 

A Look at the Historical Correlations

 

In the attached graphic, we can see the historical correlations between one of the most popular carry trade currencies (the AUD/JPY) and the most commonly traded stock index (the S&P 500). When looking at correlation tables, a reading of 1 indicates perfect asset correlation (prices of both assets move in “lockstep” 100% of the time). A reading of 0 indicates both assets have no correlation (move randomly with respect to one another), and a reading of -1 means that both assets show perfect negative correlation (move in opposing directions 100% of the time).

 

Looking at the correlation chart, we can see that the AUD/JPY and S&P 500 show a reading close to 1 for most of the charted time period. Over the 6-year period, there are only three brief intervals where this correlation breaks down into “random” territory and, on the whole, this suggests a highly reliable relationship that can be used as additional information when trades are placed. Of course it should be remembered that these relationships can change.

 

If, for example, Australia decided to drop interest rates to 0%, the AUD/JPY would no longer qualify as a carry trade (and the correlation relationship would no longer apply). For this reason, it is unwise to base trades solely on these types of correlations. A more prudent approach is to use these relationships in conjunction with other forms of technical analysis in order to improve probabilities for gains. The main point to remember is that correlation tables that show asset relationships closer to 1 (or even -1 for opposing trades), tend to provide the most reliable signals.

 

Using Inverse Correlations

 

A final point to remember is that we are not limited to assets with positive correlations when structuring trades. If fact, negative correlations can be equally valuable as long as we understand what this relationship suggests. For example, Gold is typically though as as a safe haven asset, with a negatively correlated relationship with JPY carry trades. In these cases, technical events that are bullish for Gold should be viewed as bearish for carry trades (such as the AUD/JPY or NZD/JPY). In a hypothetical trading situation, occurrences like oversold conditions for Gold would actually suggest future selling pressure for carry trades, as a bullish correction in Gold would become more likely. Conversely, overbought conditions in Gold would suggest that pairs like the GBP/JPY are likely to experience a rally going forward.

 

Conclusion: Understand the Relationships between Different Asset Classes

 

Currency correlations provide traders with valuable information that all types of strategies can utilize. Calculations like correlations tend to be used more by fundamental traders but it is important for technical charting traders to understand these developments as well. Anything that can turn the odds in your favor when placing a trade should be used and acted upon, and the performance of correlated (or even negatively correlated) assets can signal some key ways trends are likely to develop in the future.

Capture.PNG.8b0d37f7ccaef43399e43e4e811ba49d.PNG

Share this post


Link to post
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.
Note: Your post will require moderator approval before it will be visible.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.


  • Topics

  • Posts

    • AMZN Amazon stock, nice buying at the 187.26 triple+ support area at https://stockconsultant.com/?AMZN
    • DELL Dell Technologies stock, good day moving higher off the 90.99 double support area, from Stocks to Watch at https://stockconsultant.com/?DELL
    • MCK Mckesson stock, nice trend and continuation breakout at https://stockconsultant.com/?MCK
    • lmfx just officially launched their own LMGX token, Im planning to grab a couple of hundred and maybe have the option to stake them. 
    • Date: 2nd April 2025.   Market on Edge: Tariff Announcement and Volatility Ahead!   The US economic and employment data continues to deteriorate with the job vacancies figures dropping to a 5-month low. In addition to this, the IMS Manufacturing PMI also fell below expectations. However, both the US Dollar and Gold declined simultaneously following the release of the two figures, an uncommon occurrence in the market. Traders expect a key factor to be today’s ‘liberation day’ where the US will impose tariffs on imports. USDJPY - Traders Await Tariff Confirmation! Traders looking to determine how the USDJPY will look today will find it difficult to determine until the US confirms its tariff plan. Today is the day when Trump previously stated he would finalize and announce his tariff plan. The administration has not yet released the policy, but investors expect it to be the most expansionary in a century. President Trump is due to speak at 20:00 GMT. On HFM's Calendar the speech is stated as "US Liberation Day Tariff Announcement". Currently, analysts are expecting Trump’s Tariff Plan to impose tariffs on the EU, chips and pharmaceuticals later today as well as reciprocal tariffs. Economists have a good idea of how these tariffs may take effect, but reciprocal tariffs are still unspecified. In addition to this, 25% tariffs on the car industry will start tomorrow. The tariffs on the foreign cars industry are a factor which will particularly impact Japan. Although, traders should note that this is what is expected and is not yet finalised. Last week, President Trump stated that he would implement retaliatory tariffs but allow exemptions for certain US trade partners. Treasury Secretary Mr Bessent and National Economic Council Director Mr Hassett suggested that the restrictions would primarily target 15 countries responsible for the bulk of the US trade deficit. However, yesterday, Trump contradicted these statements, asserting that additional duties would be imposed on any country that has implemented similar measures against US products. The day’s volatility will depend on which route the US administration takes. The harshness of the policy will influence both the Japanese Yen as well as the US Dollar.   USDJPY 5-Minute Chart   US Economic and Employment Data The JOLT Job Vacancies figure fell below expectations and is lower than the previous month’s figure. The JOLT Job Vacancies read 7.57 million whereas the average of the past 6 months is 7.78 million. The ISM Manufacturing Index also fell below the key level of 50.00 and was 5 points lower than what analysts were expecting. The data is negative for the US Dollar, particularly as the latest release applies more pressure on the Federal Reserve to cut interest rates. However, this is unlikely to happen if the trade policy ignites higher and stickier inflation. In the Bank of Japan’s Governor's latest speech, Mr Ueda said that the tariffs are likely to trigger higher inflation. USDJPY Technical Analysis Currently, the Japanese Yen Index is the worst performing of the day while the US Dollar Index is more or less unchanged. However, this is something traders will continue to monitor as the EU session starts. In the 2-hour timeframe, the USDJPY is trading at the neutral level below the 75-bar EMA and 100-bar SMA. The RSI and MACD is also at the neutral level meaning traders should be open to price movements in either direction. On the smaller timeframes, such as the 5-minute timeframe, there is a slight bias towards a bullish outcome. However, this is only likely if the latest bearish swing does not drop below the 200-Bar SMA.     The key resistant level can be seen at 150.262 and the support level at 149.115. Breakout levels are at 149.988 and 149.674. Key Takeaway Points: Job vacancies hit a five-month low, and the ISM Manufacturing PMI missed expectations, adding pressure on the Federal Reserve regarding interest rate decisions. Traders await confirmation on Trump’s tariff policy, which is expected to impact the EU, chips, pharmaceuticals, and foreign car industries. The severity of the tariffs will influence both the JPY and the USD, with traders waiting for final policy details. The Japanese Yen Index is the worst index of the day while the US Dollar Index is unchanged. Always trade with strict risk management. Your capital is the single most important aspect of your trading business.   Please note that times displayed based on local time zone and are from time of writing this report.   Click HERE to access the full HFM Economic calendar.   Want to learn to trade and analyse the markets? Join our webinars and get analysis and trading ideas combined with better understanding of how markets work. Click HERE to register for FREE!   Click HERE to READ more Market news.   Michalis Efthymiou HFMarkets   Disclaimer: This material is provided as a general marketing communication for information purposes only and does not constitute an independent investment research. Nothing in this communication contains, or should be considered as containing, an investment advice or an investment recommendation or a solicitation for the purpose of buying or selling of any financial instrument. All information provided is gathered from reputable sources and any information containing an indication of past performance is not a guarantee or reliable indicator of future performance. Users acknowledge that any investment in Leveraged Products is characterized by a certain degree of uncertainty and that any investment of this nature involves a high level of risk for which the users are solely responsible and liable. We assume no liability for any loss arising from any investment made based on the information provided in this communication. This communication must not be reproduced or further distributed without our prior written permission.
×
×
  • Create New...

Important Information

By using this site, you agree to our Terms of Use.