Forex 4 Fun: Finding Countertrends with Correlation

How to use inverse correlation in forex markets as a way to spot bearish opportunities by comparing price action between equities and the dollar. correlation study thinkorswim
3 min read
Photo by

Many traders find they are able to spot the top of the market or a bearish trend in equities, but are not willing to pull the trigger on the bearish trade. For one reason or another, most people are wired to look for bullish opportunities, and quite frankly, they can miss the forest for the trees. But what if there were a way to spot bearish opportunities while bullish trends are occurring elsewhere, and vice versa? That's what inverse correlation is all about, and it tends to happen frequently in the forex markets—particularly when comparing price action between equities and the dollar (USD) in recent years.

Where There's a Bull, There's a Bear

In trading geek-speak, correlation has to do with how assets move in relation to one another. In the world of stocks, two companies in the same sector—say, automakers— often tend to be highly correlated (i.e., have positive correlation) and move together. Though, over the long term, the dollar and US equities have been highly correlated, recently, that trend has reversed. In other words, as the dollar has moved lower, stocks have moved higher. When stocks crashed in 2008, for example, the dollar finally broke its multi-year downtrend. When traders started piling in on equities in March of 2009, we saw the dollar take another tumble until the equities peaked in April 2010. Could this mean the dollar/equity relationship is primarily due to traders running to cash at the first sign of fear?

Correlation values vary from -1 to + 1. A negative value indicates a negative or inverse correlation. A positive value is a positive correlation. The calculation simply compares relative price moves between two instruments over a specific time. If they move up together point by point, the value will be 1, or 100% correlated. If they move opposite to each other (one moving up and one moving down point by point), the value would be -1, or 100% inversely correlated.

correlation indicator chart thinkorswim


Using the correlation indicator on the thinkorswim® from TD Ameritrade charts, you can start to gauge whether one asset tracks another in its movement, or in the case of the U.S. dollar vs. the S&P 500, they tended to move opposite of one another for most of 2010. For illustrative purposes only. Source: thinkorswim from TD Ameritrade. For illustrative purposes only. 

Based on data between January and early December of last year (see chart in Figure 1), the S&P futures (/ES) was inversely correlated (below the zero line) to the dollar index (/DX) for most of the year. Extreme readings above 0.5 have strong positive correlation and below -0.5 have strong negative correlation, respectively. Readings between 0.50 and -0.50 are relatively weak correlations. However, specific readings at certain points in time aren't as important as the overall trend for a period of time, such as the whole of 2010. How can a trader use this to his or her advantage? The trade might be to buy dollars when equities are falling, and sell dollars and buy equities when they are rising.

If the inverse correlation continues to hold true, buying dollars at resistance levels in equities and exiting dollar-long trades at equity support levels could be one opportunity. And if the U.S. economy does see the dreaded “double-dip” recession after all, what kind of returns might be made on the dollar while others flee the sinking ship of the equity markets? Are equities setting up for that next drop? Time will tell.

Call Us

Trading forex involves speculation, and the risk of loss can be substantial. Trading foreign exchange on margin carries a high level of risk, as well as its own unique risk factors. Forex investments are subject to counterparty risk, as there is no central clearing organization for these transactions. Before considering the trading of this product, please read the Forex Risk Disclosure. A forex dealer can be compensated via commission and/or spread on forex trades. TD Ameritrade is subsequently compensated by the forex dealer. Forex accounts are not protected by the Securities Investor Protection Corporation (SIPC).

Market volatility, volume, and system availability may delay account access and trade executions.

Past performance of a security or strategy does not guarantee future results or success.

Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.

Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.

The information is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.

This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.

TD Ameritrade, Inc., member FINRA/SIPC. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2019 TD Ameritrade.

Scroll to Top