Forex 4 Fun
Currency trading nuggets, one
dollar at a time.
Wanna trade forex at
TOS? To open an
account, just follow
the click path online at
> Order Types
FIGURE 1: Opposites Attract. Using the correlation indicator on the TOS charts, you can start to
gauge whether one asset tracks another in its movement, or in the case of the U.S. dollar vs. the S&P
500, they tended to move opposite of one another for most of 2010. For illustrative purposes only.
Source: thinkorswim from TD Ameritrade
Looking for bears in a bull
market? Try using correlation.
• Many traders find they
are able to spot the top of
the market or a bearish
trend in equities, but are not willing to pull
the trigger on the bearish trade. For one rea-
son or another, most people are wired to
look for bullish opportunities, and quite
frankly, they can miss the forest for the
trees. But what if there were a way to spot
bearish opportunities while bullish trends
are occurring elsewhere, and vice versa?
That’s what inverse correlation is all about,
and it tends to happen frequently in the
forex markets—particularly when compar-
ing price action between equities and the
dollar (USD) in recent years.
WHERE THERE’S A BULL,
THERE’S A BEAR
In trading geek-speak, correlation has to do
with how assets move in relation to one
another. In the world of stocks, two compa-
nies in the same sector—say, automakers—
Words by Kevin Lund
often tend to be highly correlated (i.e., have
positive correlation) and move together.
Though, over the long term, the dollar and
US equities have been highly correlated,
recently, that trend has reversed. In other
words, as the dollar has moved lower,
stocks have moved higher. When stocks
crashed in 2008, for example, the dollar
finally broke its multi-year downtrend. Perhaps coincidentally, when traders started
piling in on equities in March of 2009, we
saw the dollar take another tumble until
the equities peaked in April 2010. Could
this mean the dollar/equity relationship is
primarily due to traders running to cash at
the first sign of fear?
Correlation values vary from -1 to +1.
A negative value indicates a negative or
inverse correlation. A positive value is a
positive correlation. The calculation simply
compares relative price moves between two
instruments over a specific time. If they
move up together point by point, the value
will be 1, or 100% correlated. If they move
opposite to each other (one moving up and
one moving down point by point), the value
would be -1, or 100% inversely correlated.
Based on data between January and
early December of last year (see chart in
Figure 1), the S&P futures (/ES) was
inversely correlated (below the zero line) to
the dollar index (/DX) for most of the year.
Extreme readings above 0.5 have strong
positive correlation and below -0.5 have
stong negative correlation, respectively.
Readings between 0.50 and -0.50 are rela-
tively weak correlations. However, specific
readings at certain points in time aren’t as
important as the overall trend for a period of
time, such as the whole of 2010. How can a
trader use this to his or her advantage? The
trade might be to buy dollars when equities
are falling, and sell dollars and buy equities
when they are rising.
Trading forex involves speculation, and the
risk of loss can be substantial. Investors
must consider all relevant risk factors,
including their own personal financial situations, before trading. Trading foreign
exchange on margin carries a high level of
risk, as well as its own unique risk factors.
Forex investments are subject to counter-party risk, as there is no central clearing
organization for these transactions. Before
considering the trading of this product,
please read the Forex Risk Disclosure available at http://www.nfa.futures.org/NFA-investor-information/publication-library/for
ex.pdf. A forex dealer can be compensated
via commission and/or spread on forex
trades. TD Ameritrade is subsequently compensated by the forex dealer. Forex accounts
are not protected by the Securities Investor
Protection Corporation (SIPC).