Risk Assessment Using The Hottest Performing Equity Markets

Wild Rides in Mainland China's Equity Market
Rising 150%, Shanghai Was the Best Performing Market. Trading View

Stock markets are often a great display of social mood. When markets are lower, social mood about the economy as a whole tends to be negative such that bad news stories often get spun out of proportion as to their negative ramifications. When markets are higher, social mood often negates any bad news and celebrates any proof that the good times will keep rolling.

As Forex traders, social mood is important and stock markets can be looked at to see whether or not traders are looking for an environment of safety or an environment of risk-taking.

If markets are lower, social mood often favors an environment of safety and their specific currencies that benefit. If markets are higher, social mood often favors an environment of risk-taking and specific currencies benefit from that too. 

Which Markets to Focus On?

In short, we should be focusing on the leading equity markets. Leading refers to percent gain over a length of time such as quarter, half year, full year. When you recognize a leading equity market, you can use that as a gauge of the most aggressive moods.

Given the global market we’ve been in for the last six years, the best performing equity index has switched hands a few times. However, the top three have remained the same with a newcomer showing up late and stealing the limelight. The top three are the S&P 500, the German DAX, and the Japanese Nikkei 225. These account for the broader indices of the largest economies.

The newcomer, which is a made many brand-new investor very happy is the Shanghai index.

The Shanghai index like many other equity markets in developing economies moved sideways for a few years after the S&P and DAX moved higher followed by the Nikkei 225. However, the price and chart pattern that the developing economies displayed was a triangle pattern.

As you know, triangle patterns are lengthy and exhausting consolidation patterns.

However, once the trend resumes and the triangle breaks, the trend often resumes with aggressive force and that is exactly what happened with the Shanghai index as well as the Shenzhen. Both markets had been boasting higher than a 100% one year return by mid-June 2015. Considering the best fund managers on Wall Street are thrilled with 15 to 20% in the year consistently, you can see how a near 100% return in one year show signs of excess.

What to Watch For?

The purpose of watching these equity markets is to see if they are turning lower against the larger uptrend or resuming the larger uptrend. A continued move higher, which is the more probable move, tends to favor higher-yielding or riskier currencies. This is an extension of the popular carry trade that is commonplace during risk favoring environments where investors across the world will sell low yielding currency in order to buy a high yielding currency in order to collect the rollover.

A move lower would favor a risk-off move is developing which historically favors the US dollar, Japanese Yen and sporadically the Swiss franc. The flow into these risk-off currencies will often be determined by how far down the equity market moves.

A relatively small correction like was seen in global equity markets in January 2014 and October 2014, would likely only give these risk-off currencies a few weeks at most of the upside. As we saw in 2008, it took a rare, once in a generation events like the mortgage-backed securities meltdown to provide these risk-off currencies with months and in some cases years of upside due to the massive unwind of the carry trade and people seeking safety.

In conclusion, it’s best to wait for a key support to break as opposed to leaning on a convincing argument that a break is about to happen. Every bull market has its doubters and some are more persuasive than others but if you care about their arguments, the upside in equities is more likely as is the risk-on currency pairs.