From the July/August 2013 issue of Futures Magazine • Subscribe!

How to exploit and profit from market correlation

Markets in charge

It’s helpful to understand a bit more about these markets.

The U.S. dollar is the world’s premier currency and has been since the Bretton Woods Agreement of 1944. At that time, it was determined that all countries party to the agreement would peg their currencies to the dollar. The dollar’s influence was so strong that it maintained its status as the world’s reserve currency even after President Nixon decoupled it from gold in the 1970s. Prior to Bretton Woods, the British pound sterling was the world’s leading currency. At the time, the United States was becoming the world’s preeminent super power, and the dollar was backed by the full faith and credit of the U.S. government.

Crude oil is a commodity that affects everyone. Each time you pay a visit to the gas station, you become aware of crude oil’s economic conditions. Crude oil also is considered a barometer of how the overall economy is doing. All else equal, rising crude oil prices mean economic activity is increasing and expanding, and falling crude oil prices suggest the opposite. As consumers, we cringe at the idea of increased gasoline prices, but economically speaking this is the message. Consider a side-by-side view of crude oil and the Dow. When both are going up, it is quite often a good trading day in the making.

Stock indexes measure the overall gain or loss on any particular trading day. The S&P 500 and the Dow Jones Industrial Average are the two most-widely followed proxies for the market as a whole. For most traders, these are the markets in which positions are placed.

Metals are timeless stores of value. Gold, historically speaking, has been a hedge against inflation and often has been viewed as money of last resort. In recent years, it has served its purposes as a safe haven, built on the notion that if all else fails, there’s gold. In recent months, the fear factor prevalent in the economy has weakened, and so has gold. However, when Cyprus was falling apart, and it looked like the European Union was in danger of a breakup, gold went to highs not seen in some time. 

Keep in mind that this trading day analysis is rooted in the futures markets, which offer much greater leverage and deep liquidity. In addition, there is no thought or concern about earnings shocks, earnings reports, company malfeasance, etc. Even if you are a stock trader exclusively, this analysis affects you. If you own or trade stocks of any kind, they can be affected by the overall market, and understanding the impact of interrelated financials and commodities can give you an edge.

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