As I noted on my video recap, when the stock market is trending I tend to ignore other asset classes. After all, if you are a stock trader the idea is to focus on stocks. If anything, bearish divergences in other asset classes when stocks are in bull mode can often be seen as noise and part of the “wall of worry” that healthy markets climb. However, during corrective periods in the market uncertainty is high, and asset classes tend to see tighter correlations as the global markets jerk around in violent indecision.
The conventional wisdom is that stocks and bonds have an inverse correlation. We have also seen that a strong U.S. Dollar and Japanese Yen tend to be in conjunction with weak stocks and commodities, and vice versa. The risk currencies tend to be the Euro and Aussie Dollar. I discussed the glimmers of hope in the Euro versus the U.S. Dollar and Japanese Yen on my video earlier.
In Japanese candlestick theory, after a prior steep downtrend, a “hammer” candlestick (with a long “shadow” denoting a big down day, and the “body” on top of the candle illustrating that buyers wrestled back the initiative by day’s end) can potentially indicate an upside reversal is looming. The key is upside confirmation. Even then, there is absolutely no guarantee that it will be “the” bottom, but merely “a” bottom for a few days. With that said, we are indeed seeing upside confirmation in the Euro versus the U.S. Dollar and Japanese Yen.
In addition. note the improvement in the Aussie Dollar/Japanese Yen cross below on the daily chart, with a hammer candle on Friday after a prior very steep downtrend, followed by upside confirmation today. Keep in mind, the Euro and Aussie are still in steep overall downtrends versus the risk off currencies, which means that longs should be kept on a tight leash if you want to play for a reversal, using the hammer’s low as an excellent reference point for stop-loss placement.
Moreover, there is no telling just how powerful of an effect these looming reversals will have on stocks. To be fair, though, the Euro and Aussie did move down with stocks in April and May. So, cocky bears ought to consider easing off the accelerator for the rest of this week if stocks show sensitivity to the newfound life in the risk currencies.
Either way, in this corrective market I am going to monitor the action in the currency markets to see if these lows hold true to Japanese candlestick theory.