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Beware Unexpected Correlations Trading Patterns and Fundamentals

Beware Unexpected Correlations Trading Patterns and Fundamentals

2016-02-03 01:11:00
John Kicklighter, Chief Currency Strategist
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Talking Points:

• Underlying speculative motivations can generate unexpected correlations across seemingly unrelated assets/markets

• The 'risk' connection is the most decisive link; but commodities, US Fed policy and exchange management sync

• It is good practice to run a quick correlation coeffiecent between planned setups and existing trades

See the DailyFX Analysts' 1Q forecasts for Equities - as well as the Dollar, Euro, Pound and Gold - in the DailyFX Trading Guides page.

Having a robust strategy to select sound trade opportunities and practicing judicious money management to control risk over time is crucial to success. Yet, these elements alone may not be enough to ensure prosperity in the markets. One stealth risk that frequently undermines performance is unexpected correlation across market exposure. While two trades may have checked off all the requirements for a good standalone positions and seem different, there may be a fundamental or conditional correlation between them. This link can effectively leverage up on a single trading idea or even offset the potential each presents individually. Among the most remarkable correlations in the financial system today are those assets that can trace back to general risk trends, US monetary policy and commodities. However, there are also those links that we expect to hold which pose a risk if they inversely fail - such as loose pegs of certain currencies to the Dollar and Euro. We discuss the importance of measuring correlations and look at some of the most pressing relationships in the markets today in today's Strategy Video.

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