Confluences & Correlations

2016-09-01 | Henry Gambell

Market correlations are an interesting field of study. There are times when correlations are extremely helpful in determining what might happen in a given market. Then there are times when correlations do nothing other than promote confusion and convince traders to hold onto a losing position waiting for said correlations to kick in.

I try to keep it simple. One of the most basic inverse correlations that I follow is that of the euro against the dollar. This relationship has stood the test of time, and when referencing the daily chart, you can see not only a near perfect reflection in the price graph, but also the correlation study rarely pops above -0.90 and never gets above 0.

correlations - euro vs dollar

Another market you’ll see maintain a general inverse correlation with the dollar is gold. Of course there are times when the two may move together, but when comparing our 5 year daily chart of the two, you see the correlation histogram rarely spends any time above zero, suggesting that when the dollar goes up, gold will go down.

Market Correlations - dollar vs gold

Ok, so I make these two points to get to the third example, and that’s the euro against gold. I’ve been bullish on gold and silver for several months trading around various positions. Needless to say, the past few weeks haven’t been easy for those long precious metals. But if I’d like to hedge my position without buying puts or something similar, I might look to be short the euro. If the dollar is the inverse of euro as well as gold, then being short something like FXE carries a similar idea to being short precious metals. In the euro vs gold chart we see the correlation histogram spending the majority of its time above zero which helps confirm the idea.

Market Correlations - euro vs gold

Taking these correlations, then using the confluence of David Starr and Tony LaPorta’s take on the euro (two recently shared entries on this blog) I’m looking to buy puts in FXE using the December series in an effort to help hedge my gold idea and to get some general bearish exposure to the euro.