The stock market encompasses individual stocks that create an index or a sector. An active under trader must define an approach to the equity as it differs depending on what she or he trades. When purchasing individual shares of an enterprise, some factors such as voting rights, dividend date, earnings per share, earnings releases, etc., play an important role.
The Relationship Between Forex and Stocks
The primary principles theory behind this is when there is an increase in the equity market rise. The demand for that particular currency also rises, resulting in more fund inflow from international investors. Additionally, it generates higher demand for the specific currency, leading it to rally instead of other foreign currencies.
On the other hand, when a local stock market does not perform well, this confidence lowers, resulting in investors to take their funds and put them somewhere safer and more lucrative.
Correlation is referred to as the measurement of the degree to which prices of two things have moved in a similar direction at the same time. For instance, if A and B prices always move up and down in sync, they have a correlation coefficient of 1, which implies an ideal positive correlation.
Contrarily if the value of these things moves simultaneously in the opposite direction, then their correlation coefficient is -1, which signifies a negative correlation.
Example – Correlation between Stock & Forex Markets
If the USA stock market performs well, international investors will sell their local currency to purchase USD-denominated stocks. When the demand for the dollar rises, it experiences an increase in value. In the Foreign exchange market, USD pairs will move in favor of the dollar ( i.e., The EURUSD falling, the USDCAD rising); hence a strong US stock market will favor the value of the US Dollar.
On the other hand, if the USA’s stock market is not performing well, investors will sell their USD-denominated shares and buy stocks or ETFs in places where they can generate more yield. This shows that the economy in the USA is performing badly. Since the demand for the dollar is less, it adversely affects the value of the US dollar.
Possibility Of Negative Correlation
There is also a possibility that the currency market will rise in answer to a volatile stock market. This may happen due to tons of other factors that contribute to currency performance. We will discuss more related to this topic in the upcoming course lessons.
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