what do you make of the DOW hitting record high but EU falling? Don’t they tend to correlate with one another?
Are you referring to the EUR currency? Or are you referring to the European stock exchanges?
I believe this is just further evidence that some of the correlations have broken down. It is not the full 100% pure risk on /risk off mode that moved the market a lot in the previous years. Now the correlations have broken down a bit, and each financial instrument and currency pair can be influenced more by their own specific factors.
For example, previously, the Dow and the EUR/USD would have been fairly highly positively correlated. So if the Dow went up, EUR/USD went up as well most of the time. If the Dow went down on risk aversion, then EUR/USD went down on risk aversion. So the shifts in general risk appetite / risk aversion could cause a large part of the ODVE and MDMM and GM moves. They could cause anywhere from 50-100% of the volatility moves.
But now that correlations have broken down, the general risk appetite / aversion only causes anywhere from 0 – 50% of the movements, with the other portion of the move being due to the news/sent/fund/macro factors associated with that particular financial instrument. So you can have a situation where the DOW is flat but the EUR/USD makes a big move either to due to USD or changes in EUR economic outlook, etc. The Dow could make a big move, but AUD/USD can be relatively unchanged.
Or take today where the S&P was flat, the AUD/USD was flat, but the EUR/USD made a big move, the USD/JPY and other JPY pairs made a big move, Crude oil broke the previous days intraday support, and bonds broke out higher above previous days resistance, even though the S&P was flat.
There are so many possibilities when correlations break down.
Learn to trade in both market environments – where there is high risk on / risk off effecting the markets, and when correlations start breaking down and each financial instrument can do more of its own thing. Learn to detect both types of market environments. The daily habits, especially the correlation/sensitivity sheet should easily detect this for you.
It is actually better trading when correlations break down as what usually happens is that you can find more uncorrelated trades. And your maximum opportunity set drastically increases, even though you may be trading the same markets.
If you were only trading in risk on / risk off environments, then you may be kind of scared to place more trades as all your positions are correlated with one another, so you are either adding too much risk as, or you are hedging too much.
But when correlations break down, it forms all sorts of interesting trading opportunities.
Therefore better trading occurs when:
- Correlations break down
- More Uncorrelated Trades occur (Uncorrelated ODVE, MDMM and GM moves)
- Which means higher maximum opportunity set