Stocks and Forex: What's the Connection?

Using global equities markets to make forex trading decisions has one downside: determining which leads to which.

It's like the age-old question, “Which came first, the chicken or the egg？” or “Who's your daddy？!？”

Are the stock markets making the decisions？ Is the forex market the one that wears the trousers in the relationship, or is it the other way around？

The core assumption is that when trust in a domestic equities market rises, so does confidence in that country, resulting in an inflow of money from foreign investors.

This creates demand for the indigenous currency, causing it to appreciate against other currencies.

When a domestic equities market performs poorly, still, investor confidence plummets, prompting them to change their invested money back into their home currencies.

In principle, that sounds terrific, but in practice, it's...complicated.

The historical link between the US dollar and the S&P 500, for example, hasn't been consistent.

They've moved together, moved in opposing directions, and been unrelated throughout the last 20 years, as seen here.

However, this does not imply that the partnership is pointless.

All you need to know is when the connection is functioning (positive or negative) and when it isn't.

Here's an illustration of how stocks in the United States and Japan went in opposing directions from their respective currencies.

Any positive economic data from the United States and Japan tends to put downward pressure on their respective currencies, the dollar and the yen.

To begin, consider the connection between the Dow Jones Industrial Average and the Nikkei to show how stock markets around the world behave in relation to one another.

Since the turn of the century, the Dow Jones Industrial Average and the Nikkei 225, a Japanese market index, have moved in lockstep, dropping and rising at the same time, like lovers on Valentine's Day.

It's also worth noting that one index may take the lead at times, surging or falling first before being followed by the other.

Although it does not occur on a regular basis, stock markets around the world do tend to shift.