Question Of The Week - 12/9/2011

All markets can only do one of 3 things; trend up, trend down or trend sideways. With hundreds of markets to choose from, you can always find 2 that have a similar "up and down" pattern over a period of time. In nearly all cases, current market correlations are merely coincidence and will eventually fade. Nearly every time someone tells me "Market A can't go up because Market B is going down," within a short period, the two markets begin to diverge and stop correlating. Just because 2 markets behave similarly for a while doesn't mean they have any, real connection to each other.

For example, many people believe Gold and the U.S. dollar index should behave about the same, but that Index values the U.S. dollar to a basket of international currencies (not Gold). Gold's value (in the U.S.) is based solely on its relation to the U.S. dollar. For that reason, Gold and the U.S. Dollar Index do not need to behave in similar fashion even though one would assume (based on the name) they should.

I remember several years back when a client told me, "either my bullish Gold count was going to be wrong or my bearish Euro count was going to be wrong, because those two markets trended in lock-step with each other." Well, from January 2006 until January 2010, that was basically correct. But then, all of a sudden, from January 2010 to present, Gold nearly doubled in value while the Euro declined about 13% (i.e., the correlation ended)!

Searching through markets trying to find correlations - from my experience - is not only a waste of time, it doesn't help you make money trading. It is best to analyze each market on its own merits and avoid the temptation to "make sense" of the two scenarios by trying to get them to "agree" with one another.