Why does the -USD = +stock market?

ddrankin · August 30, 2011, 12:05am

Not all the investment is USD. So why does the dollar sink?

Clint · August 30, 2011, 2:03am

The negative correlation that you refer to (declining dollar = rising stock market) is only approximate. You shouldn’t use it as a trading signal, but it can be useful as an indicator of probable trend.

The fundamental factor which ties the dollar to the stock market in this way is risk appetite (or its inverse, risk aversion). Some traders refer to a risk appetitie environment as “risk on”, and a risk aversion environment as “risk off”.

In a “risk on” environment, the safe-haven U.S. dollar is abandoned for “riskier” foreign currencies, and ultra-low-risk investments are abandoned in favor of the “riskier” stock market.

In a “risk off” environment, the opposite tends to be true: risk averse traders and investors tend to move toward the safe-haven U.S. dollar, and away from stock market risk.

Selling the dollar does not cause the stock market to rise; nor does a rising stock market cause the dollar to fall. Rather, both the dollar and the stock market are sensitive to the degree of risk appetite, or risk aversion, prevailing in the overall financial market.

ddrankin · August 30, 2011, 7:23pm

Clint:

The negative correlation that you refer to (declining dollar = rising stock market) is only approximate. You shouldn’t use it as a trading signal, but it can be useful as an indicator of probable trend.

The fundamental factor which ties the dollar to the stock market in this way is risk appetite (or its inverse, risk aversion). Some traders refer to a risk appetitie environment as “risk on”, and a risk aversion environment as “risk off”.

In a “risk on” environment, the safe-haven U.S. dollar is abandoned for “riskier” foreign currencies, and ultra-low-risk investments are abandoned in favor of the “riskier” stock market.

In a “risk off” environment, the opposite tends to be true: risk averse traders and investors tend to move toward the safe-haven U.S. dollar, and away from stock market risk.

Selling the dollar does not cause the stock market to rise; nor does a rising stock market cause the dollar to fall. Rather, both the dollar and the stock market are sensitive to the degree of risk appetite, or risk aversion, prevailing in the overall financial market.

Thanks, Clint!