Discussion in 'Strategy Development' started by achilles28, Mar 23, 2006.
gimmie a min.
After watching currencies often lead gold, I arrived at the tentative conclusion a divergence in one could lead to a trading opportunity in the other - ie if the dollar was strong and gold unchanged, i could position myself for gold weakness.
Much to my disappoint, the predictive inverse relationship between the dollar and gold does not always hold - even when a large divergence between the two manifests itself. Yesterday was a good example - strong dollar, lagging gold, then a gold rally.
When divergent, sometimes the relationship will hold. sometimes it won't.
Is the key to wait for the lagging instrument to establish direction and then trade the trend?
Also, what other intermarket relationships should I be looking at?
Take a look at the complete history before you hold these correlations to be true. Maybe even do some regression analysis if you are really serious about it. When you see these market relationships you must also ask yourself, is this a correlation or causation? If it is the former, how does this relationship hold true?
I don't really see but a casual correlation between the two myself. The price of gold, other than the news about supply and demand for the metal, is inflation. Gold has been a traditional inflation hedge, and thus the price of it will somewhat reflect investors inflation anticipations.
The dollars movement that can be attributed to news, excluding US economic reports, is US interest rates. Interest rates are usually risen to suppress price inflation.
I can see how these 2 items might overlap at times, but I don't think the market relationships we casually see can be given any faith without rigorous review.
This is not serious corelation... dollar vs gold.
It's not hedging either... it's called directional betting.
High corelations can be found between GOLD and:
(1) major gold stocks whose production not hedged
(2) gold stock funds
(3) any specialty gold financial products
You buy the lag... and short gold futures.
Or you short the lag... and buy gold futures.
But you have to be experienced in this niche... and be creative.
Time frame: minutes/hours/days.
Also, you have to be a very good trader.
Just hedging highly corelated laggards is not enough.
historically speaking, gold has been an inflationary play - iow, gold up - dollar down - inflation up, etc.
however - let's be neiderhoffer'ian for a second - the law of ever changing cycles.
imo, the cycle has changed to some extent. gold is no longer primarily an inflationary play. it is also, to a much larger extent, a commodity play and speculative play. asia has much to do with this, especially india.
similarly, at some points during summer, the inverse correlate between QM (crude) and the ES was stunning.
QM pops, ES drops, and vice versa. you could play it like clockwork. profitably. however, any inefficiency/rule like this that becomes too well known, and too widely disseminated/incorporated by traders - ceases to be useful. it gets discounted by the market, and ceases to be valid. again, a law of ever changing cycles.
currently, everybody things that OIL up = market down, and vice versa.
however, HISTORICALLY (50 yr time frame), crude and indexes are POSITIVELY correleated - iow, oil up = market up and vice versa.
by the time the majority of people (ie the "DUMB MONEY") start to glom on to a correlate, the correlate is in the process of dissapearing or even reversing
so keep in mind that longterm - higher oil = HIGHER equity prices.
I agree totally. Thats why I started the thread - with the hope a more methodical traders has gone before me and might throw me a bone.
Redman - thanks for the good info. I didn't realize there might be a tradeable delay between gold spot and gold futs/stocks/funds.
But whistars' post contains practical wisdom and encapsulates a doubt I had about the longevity of tradeable divergences - they cannot remain synched indefinitely because the entire market would catch on and render the inefficiency untradeable.
Is the tradeable lag between gold spot and gold funds/stocks something thats perennially existed? If so, why hasn't the market traded this inefficiency into the ground?
There was also another interesting thread by a trader who used currency movement as a predictive indicator to significant moves in other, presumably, unrelated markets (non-currency markets.)
I'd like to learn more about this since I trade primarily currencies and want to expand my portfolio of traded instruments.
Thanks to you both for the good information.
My favorite is looking at silver versus bonds. You need to realize why the dollar/gold relationship exists. It is because gold is viewed as a proxy for the dollar and is priced in in dollars so , if the dollar falls the price of gold needs to rise. This only explains the price action if we assume the price of gold relative to the dollar remains unchanged. If the value of gold changes relative to the dollar then the relationship will seem to decouples.
What you need to do is look at the ratio of the price of gold to multiple currencies so you can see if gold is changing relative to the dollar or if it's own value is changing independent of the dollar.
I also did a thread on intermarket divergence a while ago . Please take a look at it .
I personally specialize in interest rate sensitive equities.
There are endless corelations between the bond market and such equities.
But just to give you a gold example...
Look at the GLD vs IAU chart... 2 gold fund products:
Probably about 0.950 corelation or higher... looks like one line.
Why? Because people are arbing these funds vs each other and vs gold.
Any lag might last for a matter of minutes.
I'm sure I could do well arbing all the gold stuff...
But I just don't need it because I got 100s of securities to arb already.
That's an educational example.
But you really need to build an entire universe of ALL gold funds, stocks, futures, options, etc...
And build long/short baskets...
Trading in and out at high volume.
If you can't take it from there...
And build the quantitative analysis software and infrastructure to track and arb these securities...
Then I can't help you any further.
The biggest pitfall I see in your thinking...
Is the belief that you can arb ** moderately corelated ** securities.
0.600 corelation is a mirage and the road to ruin.
People can justify their denial any way they care to. <yawn>
I deliberately showed you 2 securities on ** different exchanges ** with ultra-high corelation.
>> encapsulates a doubt I had about >> the longevity of tradeable
>> divergences - they cannot remain >> synched indefinitely because the
>> entire market would catch on and >> render the inefficiency untradeable.
Temporary mispricing (hours or days) happens all the time...
But tends to occur in obscure, complex, or lo volume securities.
This is a fact based on 300,000 trades over 12 years...
Not speculation from someone not doing this for a living.
But you probably cannot make it work big time... without building proprietary software systems.
(I have a Computer Science degree).
If you have a very specific question... feel free to PM me.
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