22 October 2011

Information Passage in Forex and Stocks

What kind of information would be passed between the forex and equity markets. The valuations are not themselves consistent. But the question is, to what extent does this lack of consistency make for those stable structured trends in the forex market which may be consequent on activity in the equity market.

That is, the trend is exactly the efficient processing of this pricing by the forex market. Why would this be like an Elliott Wave. Firstly, only some trends are. One might say that an entire Elliott Wave describes this process, and partial ones do not (that is there are from a functional perspective no partial Elliott Waves).

I would say this because partial Elliott Waves may in this case be inefficient processing of prices and the market takes apart inefficiency and makes this inefficiency itself efficient, that is they may signal non-continuation. That one might assume that pricing processing gets taken apart except in special circumstances. What I have noted is the tendency for them to take place during certain equity action.

This is an idea of the forex market being a source efficiency across markets, an efficiency aimed at processing pricing inconsistencies, to the extent it can. I propose this because one can interpret the crystal clear patterns at random occurrence in forex as being consequent on processing an input coming from an external source.

One might suggest that some pairs are more efficient than others, which may be a function of inputs to the pair as valuation systems, such as interest rate differentials, which may work for or against pattern decay.

Traders expect these patterns and may partly make them, thus these patterns could be used to establish pricings. But when taken into forex, because they have such random beginnings, they are ridden rather than made. But one would not expect a symmetry between activity in the equity and forex market, either in temporal terms or in terms of patterns.

If there was such symmetry one might in theory even expect trends which never ended, except for the fact that inefficiency is introduced by random inputs which degrades the trends.

However given the long term trend in EUR/USD up till the crisis one might suggest that there was an imposed symmetry between equities and what this currency was riding, namely a lack of clarity about asset valuations. Not a criticism, by the way, I believe that the predication of the housing boom was a pretty noble idea and perhaps valid in terms of future projections on assets.

But there is not explicit support for this in housing markets nor is there support for or expectation of the consequence, though efforts have been made here since the crash. Retuning of some kind is perhaps needed, not cancellation. Turing this into financial instruments was logical, but they needed to be explicitly tradable so the market could do what it does value in a functional manner, to the extent it can.

This is a market behavior view of those interest rate differentials and their effect along with valuations which were based on a bubble.

This is similar to future projections, which are a perfectly acceptable way to value assets in market, and is the foundation of wealth generation. The Dow has always risen again on a kind of re-computation of how to make the valuations it rejected in the past viable and foundational.

There seem to be at least local limits on this which may be a function of wealth generation and diffusion, but the economy always finds a way. What I am suggesting is that diffusion via house ownership, is a foundational way forward.

This is another reason for perhaps continuing with the project of widening mortgage availability (but how can one really do otherwise). But when the assets are bubbles, the assets collapse, but not the market.

Thus the market deflates, it does not crash but it has problem rising as assets have to be re-flated somehow. In a recession near depression asset values decay and the market collapses and has great difficulty rising.

That is the deflation fall behaves like a fall from a high in a day trading forex environments, it simply cascades with sell orders which are not tied to underlying asset valuations (as these do not exist in forex and in such a state of equities, they have ceased to exist, plus as noted there seem to be a decay factor associated with rising such valuations with money flow).

This is why it is important to look for signs of company growth, this will provide a basis for a future projection, assuming asset values do not eventually decay (a very important assumption in an extended market deflation period).

To project future assets one needs a belief that it is possible. Is this any way like forex. For starters one has no such belief that valuations of pairs will rise, many trading strategies simply remove such predictive beliefs and in effect believe in the random appearance of non-correlation or the dis-appearance of local correlations which may be anti-correlated to global correlations of some kind.

It is perhaps this issue of random correlations, that is they turn on and off at random (or are turned off by in effect anti-correlations), even if there is a global correlation. This may be because there is no stable long term global correlation in forex, like growth and processes in the Dow may provide for equities.

So we can still look for signs of the processing of pricing or other postulated functions of the forex market in its interaction with other markets. This is a stable global correlation but one which is divorced from pricing that is it is asymmetrical.

But we must assume that the inputs into pricing from non-correlated and asymmetrical sources makes perhaps the occurrence of these signs random and more probably the appearance randomly visible.

But one might ask if the increasing stability of such events a sign of the capacity to project future prices returning in general, which was something suggested in this blog a while ago, that the forex market may functionally do. That is its role is as a functional stabilizer, but what it may functionally stabilize is a function of what the other markets need to happen.

Now what this means is that markets cannot function correctly as systems. This does not mean they crash, that is a normal function in fact it could be argued it is a correct function of markets to revalue assets, in effect. But it does seem that markets get dysfunctional in terms of any rational function.

Now this does not mean it is not rational to highly value a company, on future projections, or exuberance, it is entirely rational and indeed it creates a rational incentive for participants to buy shares, that is to bias the market towards growth. But this capacity can decay on itself, precipitating a fall where one may not be necessary.

For example, did financial shares really have to fall as far as they did from the crisis. One can analyze statements and make an argument for present correct valuations, but on normal market functionality they seems dysfunctional valuations.

Now the severity of the move down was a function of intense short selling, which because it is a high risk high reward payoff or forced, makes for such intensity, like spikes in many ways in forex. But normally in forex, this makes for a rise, sometimes a hard bounce, sometimes a moment for the beginning of a new growth cycle.

However as we note often, that growth rise retraces, perhaps because the market itself cannot sustain this functionality, in the wake of its previous function. This is another case of inputs having random effect on market functionality, making predictions of function difficult.

So we are suggesting a kind of functional stabilizing effect of forex on equities. And in this may be the source of plunges of valuation, but they happen due to large scale structural events, not for local structural events, making tradable visibility with day trading on leverage problematic.

But why would forex do this, because of its function to optimize very precisely exchange rate differentials, it may have evolved a larger scale effect of this functionality.

What I mean by all this is that plunges of valuations correlated and asymmetrical across market in special circumstances may be highly incidental to the market, if entirely not incidental for traders.

Correlated and symmetrical would be a traders dream and would be taken apart quickly by the market, but it can exist in special circumstances but even in the crisis, where parts of the auction house ceased to exist (and have they yet reformed), there was what seemed like randomness in its occurrence. This may be because of information passage between markets.

This blog noted correlations between EUR and the market after the crisis, and during it. This can be supposed as plunges of such magnitude that a global function of the forex market was created such that equities and EUR/USD correlated.

For what reason is unclear, but complex systems do not need reasons, they just do, which is why it is so hard to gauge causality. The question to ask now, is this correlation here again or has the market changed. There was perhaps a disengagement of this causality months ago. The question to ask, was this contingent on hard wired programs in the Dow associated with growth.

primary process (Dow) - > growth - > anti-correlation with forex - > re-engagement

That is the information being passed is function, which is something that systems do, of all kinds, from quantum to biological to neural to system design itself. The issue as always is ensuring this information has any functional value when passed.

© 2011 Guy Barry - All Rights Reserved.