Dogs wag their tails much of the time, but not continuously. When they're on the move they sometimes pause in their wagging, but they will inevitably start wagging again. When you pause to think about it, you will realize that the tail, being inextricably linked to the dog, must always follow the dog. To know which will lead and which will follow, you only need to be able to distinguish the tail from the dog.
There is really no secret at all. You will find it productive in intraday trading to keep a close eye on the dollar. The forex and bond markets are the big dogs and the equity markets are the tails. This is most pertinent to the major equity indexes versus the forex market and much less so to individual equities. In the long run, the equity markets could appear to become less tightly tied to the dollar's value if the intrinsic value of equities were to change significantly in a direction that counters the dollars move, but in the short run the dollar and the dollar denominated major indexes should move in opposition, i.e., if one moves up the other should move down. To simplify this relationship, think of it this way. Assume the composite intrinsic value of the S&P changes very slowly, surprisingly slowly in fact. Now imagine that yesterday the composite intrinsic value denominated in dollars is "X" and the Euro relative to the dollar is @ 1.295. If today the Euro is up @ 1.300 versus the dollar, what should "X" be in dollars today relative to yesterday, assuming the intrinsic value of the S&P hasn't changed? The value of the dollar has gone down relative to the Euro. Consequently the S&P will be worth more denominated in dollars (less denominated in Euros) than it was yesterday. The S&P should go up. And that is what you see on a short time scale. Conversely, when the dollar moves up in value relative to the Euro, the S&P tends to move down. So if, for example, you see that overnight there was a relatively large change in the value of the dollar, but this was only weakly expressed in the overnight S&P futures, i.e., they were steady or perhaps even moved in the wrong direction, you could reasonable expect the situation to be corrected when the market opens in the morning. Let's say the dollar went up significantly overnight but the futures actually moved up as well. Then, on the open, the dollar continues to climb, or at least refuses to fall. You would expect, with high probability, that the Futures, and the S&P, would fall. When I am trading the S&P futures during the day, I keep a close eye on the dollar futures (DX). The DX, although based on a basket of currencies, is heavily weighted toward the Euro. That is reasonable since the Euro is the currency of the worlds largest, in aggregate, economy. Alternatively, you could monitor the Euro/USD. You will notice that this Forex pair moves, as it should, in consort with, rather than in opposition to, the broader US equities markets. This is why I say the Fed has it within their power to move the markets -- even though guys like deadbroke apparently think the Fed is powerless and that I am nuts. By this I don''t mean to imply that the Fed is in there every day trying to screw us by pushing the value of the dollar around, because Forex market forces of supply and demand have the upper hand, and there are many Central Banks around the world that have a vested interest in supporting the dollar and will intervene from time to time in the Forex markets to do just that. But the Fed certainly can influence the value of the dollar via their weak dollar/strong dollar policies, and consequently their policy decisions do influence the market. We can see a rising equities market without any significant rise in its intrinsic value if the dollar falls rapidly.
Thanks Piezoe. Very clear writing and thinking. I follow EUR/USD (in fact I trade it), and I have observed what you wrote. Moreover, there are nuances in what you wrote that lead to some new insight for me. In relation to EUR/USD, I have this comment. When it rises for instance, it could be that it is EUR that appreciated (rather that USD that weakened?), the effect may not be there on stocks? However given that you use DX, I think the latter remark is less important, because a measure of the dollar against a basket should tell whether it is the dollar that weakens or strengthens. In relation to currencies, I recently noticed "some strange" behavior of EUR/USD vs. USD/JPY. Sometime in the past, it used to be that these pairs moved in opposite directions (which make sense), but recently I noticed that EUR/USD and USD/JPY can move in the same direction during the trading. I have given it my interpretation, but I am not sure. Any insight on this? Another pair that seems to go with stock market is AUD/JPY. I am looking for more understanding other than an interpretation such as the JPY is the banking credit center for equity positions and when people buy the short JPY, and AUD is a reflection of the commodities as an important engine of the stock markets. In relation to the bond market, my thinking is that if bonds go up it would mean money s going to bonds, and if it is leaving stocks, the latter would go down. In addition, if the money is heading to bonds, it would mean that there is less risk appetite, and it could further mean , from a fundamental point of view, that stocks are riskier compared to bonds, and therefore a rise in bonds should be associated with a rise in volatility of stocks or/and a decline in equities. Do you agree with this view? Comments are also welcome.
Yes, I agree with your view, in general, but note that the market tends to do best when both stocks and bonds are rising simultaneously. This can occur in a healthy economy when interest rates are going down. This pushes bonds up and makes corporations happy as well. One other observation. Do a line plot of DX and it will be obvious that the dollar futures have been going down fairly steadily from June 7 or 8. There is a spike in about the end of June that seems to be anticipating the 4th of July weekend when the market briefly tanked, then the dollar continues its downhill slide. As long as this trend in DX continues I think we might expect the general trend of the market, on average , to be up, but with plenty of burps...