Market Correlation - What is It?

M

MarketTeaLeaves

Often I'm asked what is Market Correlation and why do you adhere to it? The answer to this question is quite deep and not easily answered.

Market Correlation is a strategy. It is a way and means to determine what might happen in the markets if certain conditions are present. Case-in-point; in the Forex markets we're accustomed to correlated pairs. We know that usually when one side of the pair is either long or short, the other side is doing the exact opposite. So if it's possible for currency pairs, would it not be possible for the markets in general?

So here's a question for the group in general: Do you believe that markets could be correlated?
 
Of course markets are correlated, however those correlations change dramatically over time. It depends upon which time frame you're looking at in addition to which asset classes you're covering.

US Treasuries and the S&P on a monthly time frame are anywhere from +1 to -1 and everywhere in between, but tend to be far more negatively correlated on shorter time frames.
 
Yes I do believe that markets can be correlated. My take on it is that when institutional traders take macro economic positions they trade a variety of similar instruments that they believe will reflect their view. By using similar instruments they can break up their order which reduces the impact it has on prices (this keeps slippage low and also prevents other traders from discovering their position). In very liquid markets it usually takes multiple institutions trading with a similar view to move prices, and if they all break up their positions into similar instruments what we are left with is large scale buying or selling across similar instruments. This can cause correlated price movement in those instruments. That's just how I look at it.
 
Actually global markets are heavily correlated during crashes and become less correlated as the recovery ensues. The lowest correlation is to be found at the peak, right before another drop.
 
Quote from Epic:

Actually global markets are heavily correlated during crashes and become less correlated as the recovery ensues. The lowest correlation is to be found at the peak, right before another drop.
More...

That's an interesting point. Is there a study, paper, or graphic to corroborate this statement?
 
Epic,

I think you're pretty much right on. Look at what's been happening this week on the Dow. The markets aren't correlated yet it keeps going to a higher high. The USD is trading higher and yet the market goes higher. It seems as though no one is concerned or considering fundamentals.

Thanks for the reply...
 
Folks,




Here's my analysis for today. These numbers were taken at 5 AM EST.




US Dollar – Up at 82.490 the US Dollar is up 175 ticks and is trading at 82.490.
Energies – April Oil is down at 91.54.
Financials – The 30 year bond is down 4 ticks and is trading at 141.27.
Indices – The March S&P 500 emini ES contract is up at 1546.75 and is up 16 ticks.
Gold – The April gold contract is trading up at 1579.00 and is up 39 ticks from its close.

Quick Note: Unless otherwise shown the above contract months are now June.

Conclusion
This is not a correlated market. The dollar is up+ and oil is down- which is normal but the 30 year bond is trading lower. The Financials should always correlate with the US dollar such that if the dollar is lower then bonds should follow and vice versa. The indices are up and the US dollar is trading higher which is not correlated. Gold is trading up which is not correlated with the US dollar trading higher. I tend to believe that Gold has an inverse relationship with the US Dollar as when the US Dollar is down, Gold tends to rise in value and vice-versa. Think of it as a seesaw, when one is up the other should be down. I point this out to you to make you aware that when we don't have a correlated market, it means something is wrong. As traders you need to be aware of this and proceed with your eyes wide open.


The monthly jobs numbers were just posted and whereas the futures are higher, the USD went to a high of 82.960 on the June contract and yet the indices are trading higher. It doesn't appear as though this is a correlated market. One of my trading rules is to not trade on Jobs Friday as the markets don't appear to act with any sense of normalcy.

What do you think??
 
Quote from dtrader98:

That's an interesting point. Is there a study, paper, or graphic to corroborate this statement?
More...

There are many studies on it. I read one recently by analysts at Goldman Sachs, but it was an internal study so you might not be able to look it up online. Don't think they published it outside of GSAM.

I've done a lot of study on the topic myself as well. It is very obvious. The only strange correlation recently has been treasuries and equities making new highs simultaneously. That will come to an end as soon as inflation starts to pick up just a little bit. My estimate is within the next 18 months.
 
Just attended a webinar where the lead trader was supposed to show the audience how to make money trading the Russell and LOST money doing so. What he forgot to look at was the USD trading about 700 ticks higher from its close. Guess there's something to this market correlation stuff.
 
You must log in or register to reply here.
Back
Top