In our first segment regarding the subject of market correlation, we provided readers with a broad brush view of market correlation and how they could potentially profit from this. But the question that has arisen is what do you do if the market correlation that I describe in segment one isn’t so clear cut? Some comments would include “you provide us with a daily bias of the markets even when they aren’t correlated, but you don’t explain how you came to that conclusion.” That is the purpose of this article.
As my followers already know, each day I provide an initial conclusion. In it I spell out if the market is correlated and whether or not it’s correlated to the upside or downside. I also provide a section for the market bias of the day. I might say something like “Today we’re not dealing with a correlated market, however our bias is to upside.” So the further question is if we say the markets aren’t correlated how do we determine our bias for the day?
As I’ve explained to some of my followers, market correlation does have rules associated it but on any given trading day, any rule can virtually be thrown out a window. Anyone who’s ever traded for any period of time knows this. Case-in-point this past March Mario Draghi made a comment regarding the euro whereby he basically said “we’re not concerned with the inflation aspects of the euro.” No sooner did he say this and the euro dropped like a rock, the U.S. dollar took off and the markets, although correlated to the upside, dropped for the day. The point is that anything can happen in the markets, correlated or not and it’s up to the trader to be cognizant of this. Bottom line, you have to be a good observer of the markets to capitalize on trading and that is what market correlation is about, observing the markets to profit from them. Now getting back to the original question, how would you call the following?
Now at first glance you may be thinking “well the dollar is down, oil is down and bonds are down (which is correlated) so the markets must be heading down.” Not so. True there’s no correlation between the U.S. dollar and crude, but generally during the course of a trading day this has a way of correcting itself. The bonds are down, which is bullish for the markets, and indexes and gold are trading higher. Gold in this case acts as the outlier, and gold trading higher is bullish for the markets. In this case, I would say the markets aren’t correlated but our bias is to the upside. Why? Bonds trading lower are bullish for the markets as well as gold trading higher. Now, are there other factors involved? Yes. How did the Asian markets close? Is Europe trading higher or lower? Are there factors involved? If so, what are they?
Now you might be saying, “Bonds aren’t a factor any longer and gold is trading near $1,300 an ounce.” Bonds may have dropped in price after the FOMC meeting on June 20 and gold may have dropped below $1,300, but negate their value as it pertains to market correlation. They’re still a factor.
We determine market correlation in the early AM hours prior to the market open. This is because we catch the close of Asia and the European open and we have found that over a period of time the market gravitates to its correlation over the course of a trading day. Market Correlation is three-quarters observation and one-quarter rule based.