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How does the stock market affect Forex?

How does the stock market affect Forex?
Asked by
Sam Button categorie-icon time-icon4 months ago
1 Answer Answer Question

Justin Freeman
Answered time-icon4 months ago

Economic changes and trends are the cornerstone of analysis for currency traders. In some cases the economic data used relates to trade, and in some cases it’s more related to monetary policy. One thing many forex traders don't realize is that some of these economic reports can be predicted using stock markets.

It makes sense when you think about it; because the corporations whose stocks make up the equity markets have sales, employees and offices all across the globe. And they are constantlypreparing regional reports that can provide a deep understanding of regional economic trends.

Economic Fundamentals

Just like any other asset, a currency's value fluctuates based on supply and demand. That's basic economic theory. If there's high demand a currency will appreciate, and if the supply increases drastically the value of the currency will fall. Of course supply and demand are influenced by many factors that cause constant changes in the values of all currencies. While this article obviously won't discuss all of the factors, we can gain an insight into how equity markets might affect forex.

It's Global, not Regional

Forex markets are global, and by far the largest markets in the world. Daily trading volume dwarfs that seen from equities, even on a global scale. When considering the impact equities might have on forex you need to keep a global perspective. That means a study of the largest global companies can often provide the best insight into currencies.

Major equity markets such as the Japanese or U.K. markets can also provide an insight into forex. There is a definite connection between currencies and equities.

A weak local currency is good for exporters. Because a large part of their income is in foreign currency a weak local currency means they have larger profits when converting to their local currency. Typically this is a case where the currency affects the equity markets. It is most commonly seen with the Nikkei in Japan or the FTSE 100 in the U.K. because both indices heavily favor export companies.

The chart below shows the correlation between the Yen and the Nikkei (USD/JPY is in blue and Nikkei is in red):

Forward Indicators

Foreign exchange markets move very quickly, but company profits and revenues are reported more slowly. That makes most industries a lagging indicator when it comes to forex markets. We have to wait for quarterly reports to know the effect of currency movements, and individual stocks have no real impact on such movements. When there has been a significant change in forex markets, company results can differ dramatically from analyst expectations. Many companies will give forward guidance if currencies are moving dramatically, and that can be a good time to employ hedging strategies.

Usually the best indications come from companies with a global presence, such as Hershey’s or Exxon Mobil.

Thinking outside of the United States

One way to get an idea of the future movements in currencies based on stock markets is to see where multi-national companies are investing heavily. This type of overseas investment indicates the company feels there is strong economic growth to justify their investment. Where economic growth is strong there is often a strong currency as well.

Look too at the performance of the government. A strong government balance sheet and stability will help support a stronger currency. Where there is a lot of government debt or instability there is often weakness in that nation’s currency.

In Conclusion

The fact is that stock markets don’t affect currencies, but they can give indications of the future movements in currencies due to their forecast regarding economic growth and strength. On the other hand, currencies can give a good indication of the movements in the stock market. Weak currencies are good for exporters, so a falling currency can often give a boost to a country’s stock market.

The best way to predict currency movements is to look at the economic strength of a country, and at changes in monetary policy and interest rates.

This could clearly be seen following the 2007-2009 financial crisis, where every major global government began a program of quantitative easing to help strengthen their economies. This policy greatly increased monetary supply, and in most cases led to weakness in global currencies. That weakness in currencies from 2009 through 2018 was matched by one of the longest bull markets in equities in history.

Forex markets are complex and dynamic and using a single data point to forecast future movements, such as stock markets, is limiting and not truly productive. While equities and stock markets might prove to be useful as indicators, often it is currencies that are better indicators of stock market moves.

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