Forex Trading Estate

Stocks and Forex: How Different are They?

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Some traders restrict their activities to stocks, and others choose to trade forex and nothing else. Still others choose to incorporate both of these markets, along with others, into their strategies in order to implement hedging methods and control the risk profile of the position better. But regardless of the choice, those with some experience in either forex or stocks will be quick to recognize the strong relationship between financial markets of all kinds. A strong movement in the forex market almost always has its equivalent in forex, and trends in the forex market have clear implications for stock prices.

A good example of this relationship is provided by the carry trade. Every carry trader knows the powerful correlation between carry pairs and stock market performance. AUDJPY, EURJPY, and NOKUSD pairs are all strongly correlated to the global stock markets, and this relationship usually holds even in the absence of major market shocks, and extreme events. In addition, oil and stock prices often have an inverse relationship: when the price of one goes up, that of the other falls. A similar relationship exists between oil prices and the dollar.

In the past, this close relationship was driven by major speculative actors, including hedge funds, which used the returns of the carry trade to invest in stock markets sometimes, either to reduce risk by entering trades with opposite directions, or to increase directionality by buying into the stock market of the nation of which they are also purchasing the currency. As such, a self-sustaining mechanism was created where more carry trades lead to higher stock markets, and higher stock markets led to greater carry returns. While the profit potential of this trade is obvious, the imbalances created by it are also obvious, and smooth movement of the markets do not always reflect the risk profile of an underlying trade.

Today, hedge funds have lost some of their power to drive market trends, but the relationship between forex and currencies remains very strong. Stocks are still one of the prime investment tools for investors of all classes, and the speculative money that enters a nation’s markets finds its way into the stock market sooner or later.

How can traders use this knowledge to profit from stock and forex trends? The obvious way is to join a trend when it is confirmed by both financial markets, and obviously this requires that the trader keep an eye on both fields with equal vigor. While this may not be very easy, combining knowledge of these two markets can be profit-multiplier for our trades, as we can avoid whipsaws and false breakouts with greater ease, and implement better risk controls by being up-to-date with developments in various markets.

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