Trading FX with Equities

The financial markets are intertwined and it is not strange to see events occurring in one market exerting some measure of effect on another market. For instance, activities in the equities market may affect the currency market, and this article will show two examples of how this might occur.

1)   Mergers and Acquisitions

Multi-billion dollar transcontinental merger or acquisition deals which require large amounts of one currency to be exchanged for another currency, may lead to a surge in demand of the destination currency. This effect may last for weeks. Deals that may cause this effect are usually deals of the cash-only nature. Deals that are of the cash + stocks nature are only considered if the cash component of the deal far outweighs the stock component. Deals which are paid for via stock options are not considered because virtually no money changes hands.

Deals considered here are cross-border deals greater than $1bn. In the year 2000 a study conducted by Breedon and Fornasari found that:

a)   Such large cross-border mergers and acquisitions caused a 1% appreciation in the domestic currency of the target corporation.

b)   The target company’s currency appreciated in value by 0.5% for every $1-billion deal.

c)   Strong upward movement in the currency of the country where the target company is located is seen immediately the deal is announced.

In forex, moves of up to 1% are considered quite significant.

There are several examples of where this has played out. For instance, US company Procter & Gamble’s US$4.5 billion payment for 77% ownership of Wella AG led to a 100-pip surge in the EUR/USD on the day of the announcement and a further 100-pip move the following week.

2)   Stock Markets and Forex

Some stock markets have correlations with currencies. For instance, the Japanese Yen and the Nikkei 225 have an inverse correlative relationship. When the Nikkei 225 is down, the value of the Japanese Yen rises. If we look at the US markets, we see that the US markets host stocks of companies from all over the world. When the US markets are doing well, there is usually an influx of foreign cash into the US wanting to buy US stocks. This money has to be exchanged for US Dollars. This situation creates a demand for US Dollars and may lead to a rise in its value. Similarly, if the stock market performs poorly, then there might be capital flight and foreign investors might start selling their holdings and convert their US Dollars into their local currencies.

These two examples are cases where fundamental influences have been brought to bear on the currencies concerned. However the mantra is to trigger fundamentally and enter technically. The trader may therefore still use technical modes of trade entry in deciding how to get into the market.

Usually, there are still opportunities to trade for the week with any one of these two influences, even when the initial run is missed. This will require looking out for a retracement entry opportunity when the early birds are cashing out of their initial profits.

This article is a guest blog written by easy-forex

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