We have repeatedly pointed out that underlyings such as stocks, currencies and commodities as well as bonds have their own individual price characteristics. All of these values are easy to trade. The differences are not easy to determine, since they are usually only visible to experienced traders.
This is especially true if trading is of a short-term nature. In the following we only want to go into a few correlations and differences in currencies and stock trading to get a feel for how traders could approach it.
The liquidity of underlyings
One of the determining ones The parameter of price characteristics is liquidity. This is a measure of how strongly the individual value is traded by the market participants. The currency market has the highest liquidity. Currencies are not only regarded as investment vehicles, but there are also cross-border transactions that affect the price of this market.
Accordingly, currency trading also takes place almost non-stop. Except on weekends, banks exchange currency on a daily basis - whether for real economic transactions or as part of an investment. The stock market, on the other hand, is almost exclusively intended to guarantee financing in the form of an investment. The difference lies not only in the limited liquidity, but also in the volume or tradable volume and the purpose.
But how do these differences affect the price characteristics?
How do the differences affect prices?
Based on liquidity, the following differences can be mentioned first:
- Larger trading volumes = longer trading hours = constant prices
- Smaller trading volume = shorter trading times = exchange rate gaps
- trading against different currencies = negative and positive correlating rates
- trading against a currency = dependency on a currency
these four points are only to be understood as a suggestion and also contain some difficulties of understanding that should be considered first.
(1) and (2) are mainly concerned with the relationship between trading volume and price processing. Since currency trading takes place almost non-stop, price gaps are extremely rare. The following graphic shows the difference based on the current charts S&P 500 and EUR / USD for the same period.
On the left is the US stock index S&P 500 in the form of the futures, on the right is the spot market price for the currency pair EUR / To recognize USD. The gap in the stock market arose partly because the trading volume of the futures is less than the trading volume of the currency.
The event that led to the violent swings on a short-term basis should actually have influenced the currency pair. However, since currencies are not tied to a stock exchange, such as the future, settlement can take place anywhere in the world. In addition, this balancing can be done through multiple channels, as you can trade both currencies, both the euro and the US dollar, against other currencies.
(3) and (4) also refer to this. Because of these cross-rate relationships, currency pairs have developed either opposing or positively correlating relationships. It is therefore clear that many currency pairs that are traded against the US dollar are to some extent parallel to each other.
The EUR / CHF and USD / CHF currency pairs are a good example of the opposite trend. Although one is inclined to think that both should mainly run parallel to one another, the opposite is often the case on a short-term basis, see chart.
The upper chart shows the two currency pairs EUR / CHF and USD / CHF on a 15 minute basis. It is immediately noticeable that both currency pairs often run against each other. On a somewhat longer-term basis, the prices eventually adjust - if you are a short-term trader, you need to know these divergences in order to be able to use the relationships between the currency pairs.
Stocks and currency pairs are often related to each other, For example, the correlation between the DAX and the EUR / USD currency pair is currently very high. Of course, this not only affects the German stock market, but also other stock markets that depend on the US dollar exchange rate.
The DAX is currently trending upwards if the US dollar also rises, i.e. the currency pair EUR / USD falls. There are fundamental reasons for this, which lie in the mass of investors. At the same time, the US markets should tend to weaken on a strong US dollar. In contrast, US indices correlate strongly with the Japanese yen against the US dollar, which has roughly the same reasons as the correlation between the EUR / USD exchange rate and the DAX.
Forex Trading for Beginners
Conclusion - Liquidity is the basis
The liquidity of markets is the basis for relationships and individual characteristics between price movements. Liquidity is so important because on the one hand it influences the flexibility of trading (many / few trading venues and large / small trading volume) and on the other hand it helps to spread risks.