One issue with using global equity markets to make forex trading decisions is figuring out which leads which.
It’s like answering that age old question, “Which came first, the chicken or the egg?” or “Who’s yo daddy?!”
Are the equity markets calling the shots? Or is it the forex market that wears the pants in the relationship?
The basic idea is that, when a domestic equity market rises, confidence in that specific country grows as well, leading to an inflow of funds from foreign investors. This tends to create a demand for the domestic currency, causing it to rally versus other foreign currencies.
On the flip side, when a domestic equity market performs terribly, confidence falters, causing investors to convert their invested funds back into their own local currencies.
For the past couple of years, however, this principle holds contrary for the U.S. and Japan.
Any upbeat economic figures in the U.S. and Japan more often than not weigh down on their respective currencies, the dollar and yen.
First, let’s take a look at the correlation between the Dow Jones Industrial Average and the Nikkei to see how stock markets all over the globe perform relative to each other.
Since the turn of the century, the Dow Jones Industrial Average and the Nikkei 225, the Japanese stock index, have been moving together like lovers on Valentine’s Day, falling and rising at the same time. Also notice that sometimes one index leads, rallying or dropping first before being followed by the other index. You could say that stock markets in the world generally move in the same direction.