I was also wondering about the Market Correlation/Sensitivity sheet, and I forgot to ask about it in my last email.
What do you do when a currency makes a substantial move in a direction but it wasn’t due to risk aversion or risk appetite in the market?
Like if the AUD doesn’t rise because the commodity markets are booming and people are moving their money into a riskier, growing currency.. but instead it went up due to a reaction to a fundamental news release or such.
You ask a good question about the correlation/sensitivity sheet.
You are right that there are certain days where the AUD may rise, but it may not be due to general risk appetite. Sometimes a market can rise due to just general short covering. But if the AUD rises due to fundamental news, such as something that indicates a growing or healing Australian economy, then I have no problem putting it under risk appetite. It may not be risk appetite in the general, broad sentiment sense across many markets, but it is risk appetite specific to the Australian economy.
Now, even if the AUD rises on short covering, or some other non risk appetite reason, I will still put it in the Risk appetite column. Personally I am very flexible with the three columns – risk appetite / neutral / risk aversion. I am not about to heavily tweak it and create even more columns, etc. Although, if you want you can tweak the correlation/sensitivity sheet.
For example, instead of having risk appetite / neutral / risk aversion, perhaps you may want the column names to be – up / consolidating / down.
The three column approach is not the most important part of the sensitivity sheet in my opinion. I am just trying to get a quick overview of the potential correlations and divergences on one sheet. Like if the AUD is up, and the GBP is down, then I can see the divergence and see something interesting is going on and can research it further. Of course, you can do the same by looking at a chart of GBP/AUD, but I like the three column approach as I distill all the charts down to that one sheet.
Other potential problems with the sheet can happen. For example with gold. If gold drops, it can be due to risk aversion and liquidity driven selling, so you can put gold in the risk aversion column. However, there are other cases where Gold can rise due to risk aversion and safe haven bid. Then there are other market environments where Gold can drop due to risk appetite if people are selling gold to buy assets that benefit more from economic growth or earnings growth. So I can see how you may be confused with the whole risk appetite / neutral / risk aversion columns.
When I developed the sheet back in say June 2012, there was a lot of risk appetite / risk aversion flows, so that is why I set it up like that. But in the current market environment, correlations have broken down. The AUD can rise or fall regardless of what the S&P does, etc, etc. The GBP can rise or fall and it doesn’t really care about what the S&P does right now. The USD is mixed across the board recently so I have left it out of my sheets over the past few weeks. Sometimes it may rise vs the EUR, and sell off vs the AUD on the same day. The correlations have broken down.
So if you want, you can tweak the sheet column names, or you can add more columns if you want. Be creative if you want! Just keep the core principles in mind:
- Find interesting correlations and divergences in the days trading action
- Focus on how the market responds to news
- In the note section have the closest bullish and bearish scenarios to the current market moment.
But I believe the more important portion is the notes section – where I describe the days action in one sentence or so (many times copied from my master currency files), then focus on the closest scenarios and elements to the current market moment that can come into play in the next few days or weeks. I always want to make sure I know what scenarios can cause my positions to move in my favor or against me, and what scenarios I am betting on for any fresh positions I am contemplating taking.