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Understand What a Heavy Stock Market Means For Forex

Understand What a Heavy Stock Market Means For Forex

Tyler Yell, CMT, Currency Strategist

Talking Points:

  • Stock Market Effect on FX
  • What To Focus on For SPX500 & FX
  • FX Trade on Strong or Weak Stocks

The purpose of this article is not to call an equity index like the SPX500 top. In fact, until 1830 is broken and further 1,737, I have no intention of calling a top in the S&P500. However, this article will help you position yourself in the Forex market when (not if) the stock market corrects again.

Stock Market Effect on FX

The SPX posted a bearish key day after touching all-time highs on Friday April 4th, 2013. That will likely have a lot traders worried. The psychology behind the bearish key day is that the traders who were bidding prices higher were nowhere to be found after taking profits as the sellers began to take over.

Learn Forex: Bearish Key Day in SPX500 after Posting All Time High

SPX-Bearish-Key-Day-JPY_body_Picture_2.png, Understand What a Heavy Stock Market Means For Forex

Courtesy of Marketscope 2.0

The trend is obviously very strong. However, a lot of signals are starting to creep up that we could see a move down. The obvious and worthwhile question we’re looking to answer is how does this affect FX?

Focus Points for SPX500 & FX

The most common and historical relationship shows a benefit to either the US Dollar and or the Japanese Yen or JPY when markets sell-off. Of the two, the JPY usually strengthen even more. The currencies that are often hurt when stocks sell-off is the higher yielding currencies like the Australia or the New Zealand Dollar and Emerging Market currencies like the Mexican Peso or South African Rand.

April 4th’s price action of a bearish outside day on the stocks will have us looking to key levels below as support. If support breaks as mentioned on the charts above, we could be looking at a rush to JPY and potentially the USD through treasuries but it’s important that you not front run this potential move because you could easily get blown out if you try to short a strong uptrend. The key levels of support from the SPX500 in 2014 are 1,830 & 1737.

When these levels break, and not before then, you should keep an eye on currency crosses most in tune with SPX & equities. We’ve mentioned both the JPY & USD have done best in past corrections of the SPX500.

Learn Forex: High Yielding AUD Could Lose Ground to the JPY if SPX500 Drops

SPX-Bearish-Key-Day-JPY_body_Picture_7.png, Understand What a Heavy Stock Market Means For Forex

Courtesy of Marketscope 2.0

AUDJPY does not have to be your go to currency pair should a correction develop. However, if a major sell-off develops in the near-future, you would have a hard time finding a better buy then the JPY. If the JPY weakness from 2013 resumes, then you could look to the USDOLLAR should a those key levels on SPX500 break.

Over the last 6 corrections since the March 2009 bottom, the USD has also done well. To be fair, the JPY has done better overall than the USD but if the Bank of Japan brings out another round of major easing then USD vs. Emerging Markets could be an attractive play. Here’s a view of USDMXN with the last few corrections.

Learn Forex: High Yielding AUD Could Lose Ground to the JPY if SPX500 Drops

SPX-Bearish-Key-Day-JPY_body_Picture_6.png, Understand What a Heavy Stock Market Means For Forex

Courtesy of Marketscope 2.0

FX Trade on Strong or Weak Stocks

The key take-away from this article is to understand that there is a potential high-probability FX trade when key levels in the SPX500 breaks. You have some flexibility as to what trade deserves your capital. The highest probability plays would likely be to either buy the JPY or the USD against currencies that move higher when stocks move higher.

The two currency pairs that are easy to consider would either be AUDJPY or USDMXN. Another good practice would be to continue and find the Strong Weak edge in the market when the correction takes place.

Learn Forex: AUDJPY & USDMXN Trade Triggers In the Even of SPX500 Sell-Off

SPX-Bearish-Key-Day-JPY_body_Picture_8.png, Understand What a Heavy Stock Market Means For Forex

Courtesy of Marketscope 2.0

SPX-Bearish-Key-Day-JPY_body_Picture_9.png, Understand What a Heavy Stock Market Means For Forex

Courtesy of Marketscope 2.0

Happy Trading!

---Written by Tyler Yell

To contact Tyler, email instructor@dailyfx.com

Tyler is available on Twitter @ForexYell

To be added to Tyler’s e-mail distribution list, please click here.

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