I hope your week is off to a great start!
Today I want to talk about market correlation… and how we can see correlation between multiple markets to help us in our trading.
Now, when markets are correlated, it means they are moving essentially in step with one another.
The benefit of knowing how correlated or uncorrelated individual markets are is that it can give you a broader perspective on the overall nature of the market at large…
And help you diversify your portfolio to reflect the changing degrees of correlation if needed.
Now, at Hawkeye we have a tool that was developed specifically to measure correlation between several markets or instruments…
It’s a tool called the Hawkeye Fatboy, and it instantly reveals which markets are correlating and which are not, giving you valuable insight into the overall market with one quick glance.
Here’s a look at the Fatboy set to my own personal settings.
Now, what we’re primarily looking at here is the group of wavy bands that are moving along together mainly between the green and red horizontal lines.
(The single red and yellow band across the bottom is a new indicator that’s still in development at the moment.)
Now, the first step in using the Fatboy is to set the indicator to track the particular markets or instruments that you normally trade and want to analyze for correlation.
Personally, I set my Fatboy to track equities futures across 4 major indexes: the S&P (ticker ES), the Nasdaq (NQ), the Dow (YM), and the Russell (RTY).
I also have crude oil (CL) and gold (GC) tracking on the Fatboy to help me see how they’re being impacted by the indices and vice versa.
So, each one of those wavy bands represents one of those instruments that I’m tracking.
The more tightly bound those bands are to one another, the stronger their correlation.
As the bands begin to spread apart from each other, they’re less and less correlated.
So, when two or more bands appear to be sitting on top of one another, that’s a very strong degree of correlation.
Now, looking at these particular markets and their current position on the Fatboy, we see that the Russell (the pink band) is building strength…
… While the other indices are losing strength.
But how exactly does understanding correlation or non-correlation help you in your trading?
Well, typically when you see uncorrelated markets, you can expect choppy, range-bound price action.
On the other hand, when you see a strong correlation between certain markets or instruments, you’ll typically see nice corresponding trends.
Now, here’s what’s great about the Fatboy: It doesn’t only show correlation and non-correlation.
See, those horizontal red and green bars represent areas of overbuying and overselling, so you can see where the instruments that you’re tracking are in relation to being overbought or oversold.
In essence, the Fatboy tells you three things in one easy indicator: whether an instrument is gaining or losing energy…
Whether the instrument is overbought or oversold…
And how correlated that instrument is with other instruments that you’re tracking.
Now, in the next edition, we’ll talk more about the pros and cons of trading correlated and non-correlated instruments.
In the meantime, you can learn more about the basis of the Hawkeye methodology and our flagship indicator by watching a comprehensive training video — just click here to view it now!