Why the Dollar and Stocks Don’t Predict the Other
The U.S. dollar and the U.S. stock market don’t always move against each other. The traditional wisdom in this respect is that when the dollar moves in one direction, stocks move in the opposite direction. However, going blindly with conventional wisdom is never a good idea. Although it works sometimes, for binary options traders, it doesn’t work often enough that you are likely to lose money long term just by trying to trade according to generalities. Looking at a case where this was clearly the case can be a good illustration of what not to do, and help us form a better idea of what you should do if you want to be a profitable trader.
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On Tuesday, December 6, the U.S. dollar advanced in a very small manner against the three other major currencies. It gained 0.019 percent against the euro, 0.076 percent against the British pound, and 0.096 percent against the Japanese yen. These are minor advances for the dollar, but they are advances nonetheless. Looking at a daily chart of each shows a definite upward trend, indicating that call options were far more advantageous than put options. Yes, there were instances where put options would have been beneficial to you, especially if you had used 60 second options. And while this is true, the timing of these trades would have been much more difficult to perfect in this instance, even with the high quality use of technical indicators.
On the same day, the Dow Jones Industrial Average improved by 0.18 percent, the S&P 500 moved forward by 0.34 percent, and the NASDAQ increased by 0.45 percent. These are the three main indicators that show what stocks as a whole are doing, and although they’re not a perfect representation, they tend to accurately show what the economy is doing.
It’s no secret that the dollar and the major U.S. indices have an inverse correlation to each other. The mechanics of how the economy works makes this a necessity. An expensive dollar makes it harder for international investors to buy U.S. securities, and this tends to make the cost of doing business too high for both to move in the same direction. And when the dollar is weak, investors are capable of buy securities at a virtual discount, leading to an increase in business on the stock market.
The thing to keep in mind with this relationship though is that although it is an inverse one, it is not an immediate reaction. The trends that occur within these two distinct markets is a long term one, relying on overall trends within the economy as a whole. And even though the overall relationship is an inverse one, it is not perfectly inverse. Statisticians assign a numerical code to correlations ranging from -1 to 1. An assignment of 0 indicates that the relationships are perfectly random. When the number is positive, the correlation means that the two different relationships tend to move in the same direction. The closer to 1 the assignment is, the more perfectly they move together. The same is true of negative numbers. The closer to -1 the assignment is, the more perfectly they move in opposite directions.
The relationship between the dollar and the indices is not right at -1. It varies over time, but the current standing grants the relationship at only about 35 percent when all of the different indices are accounted for. That means that even though the two move against each other, it is more closely tied to randomness than to actual relationships. For those that try to base one off of the other with concepts like the market pull effect, they will find that they are losing money.
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