Is stock market influences forex, or forex influences stock market? The correlation between stock market and forex is hazy at most, and sometimes simply superstition.

Is stock market influences forex, or forex influences stock market? The correlation between stock market and forex is hazy at most, and sometimes simply superstition. There are no guarantee that if stock market fall then currency will fall or contararily go up. In different circumstances, different responses may arise.

 

How The Correlation Established

Between stocks, bonds, and currencies, the one considered as the fundamentally-safest asset is most probably stocks. Thus, there are many events when money flows from currency to stocks following risk-avoidance sentiment. However, it is just a general concept, and does not apply to all pairs but a few that related to US Dollar and Japanese Yen. Even then, the relationship is not so easily defined.

The premise here is that when confidence toward a certain country's stock market rises, then demands for the country's currency will increase as well because investors will need the funds to buy the country's stocks. There has been many evidences when US Dollar rises following Dow Jones, NASDAQ and S&P500 strong gains. Similar correlation has also been spotted between Nikkei and Yen.

In the following picture, you can see the Dow Jones Index, one of the US main stock indices, related to AUDUSD and GBPUSD rallies between July 2008 till June 2009. It can even be said that sharp stock gain triggered US Dollar bullish rally in the two pairs.

forex and stock chart

However, it is also possible for currency's exchange rate to appreciate during stock market decline because investors that liquidate their assets may turn from a country's stocks to the said country's currency. Just because investors consider the country's stock market performs poorly, does not mean that they also think the country's doomed, thus they may hedge by holding on to the currency instead. But if unfavorable circumstances stays, then stock market decline may also lead to capital outflow which consequently push currency exchange rates down.

 

Shaky Relationship

The key factor here is that a country's currency is needed to buy the country's stocks, thus better business climate that lead to improved business performance is expected to grant higher gains for stock traders and investors and consequently may result in stronger exchange rate.

But in reality, the positive correlation between stock market and forex is not a sure thing. It will likely happen only if certain fundamental premises are fulfilled, that is: investors believe the country's in decline and any signs of improvements will affect their future gains. To get a better understanding, see the following picture about relationship between Nikkei and USDJPY in an eleven years time between 2000-2011.

Nikkei

As you can see, there are periods when Nikkei and Stock Market moves in an absolute opposite direction, and their positive correlation only emerges later.

The shaky relationship can be further seen in the following graphic about Dow Jones and USDJPY between 2000-2012. 

Dow

There are random instances when the Dow and USDJPY moved to the same direction, but more often than not, they moved to different direction. We can argue that USDJPY pair is more influenced by Nikkei rather than the Dow, but it does not deflect the problem of imperfect positive correlation.

Is that mean the correlation between stock market and forex is a dud? It's not necessarily so. It is just that when we analyze the market, we have to take many things into account, not merely one or two factors. Although monitoring stock market is beneficial for forex traders, ordinary fundamental and technical analysis are important too. Understanding correlation between stock market and forex is also advantageous when you are in quandary between bullish fundamentals and bearish technicals or vice versa, because it can give you better perspective in analyzing the current trend in international financial market.