No BS Day Trading - Why I don't trade correlations
I will sum this up in one sentence and then explain my viewpoint…
Don't try to find correlations between different markets.
When I first started making some money trading the treasuries, I decided that
maybe there was a solid inverse correlation between the treasuries and the stock
market and maybe I could add that indicator to my arsenal of clues. It's a common
belief because, at times, the two markets can clearly move in an inverse fashion.
Stocks go up and treasuries go down. Stocks go down and treasuries go up. Seems
to work like a charm. Except then it doesn't.
I had a small run where I made a few dollars trying to trade the inverse
correlation. However, the reality is that the good trades would have also been
considered good trades if I was just basing them off of the action in the treasuries
alone. I then had a string of losses which were a result of having no read in the
treasuries but having a read in stocks. Instead of trading the S&P, I made an inverse
trade in the treasuries. Stocks would run highs, treasuries would do nothing. Stocks
would pull back, treasuries would run in my face and I would take a loss. Stocks
would then chop around for an hour and finally run new highs again. I would sit there
and do nothing. Treasuries would tank. And so it went. I probably made the right call
on the stocks 8 times out of 10 and yet would go 0 for 10 on the inverse treasury
trades. After beating my head against a wall for several weeks, I finally abandoned
this tactic which was clearly not working.
I have never found a reliable correlation setup of any kind. If you focus on stock
indexes and see a setup in the stock indexes, just trade the stock indexes. If you see
a setup in treasuries, trade the treasuries. Traders often try to find clues in other
markets as well such as oil, gold, currencies and the like. The real clues are in the
market you're trading. If you are focused on the ES running highs, you may miss the
fact that the 5-year notes are near an obvious support level and sellers are showing
zero interest in even getting the 5-year to that support price let alone selling through
that price. So you short the treasuries, the support level holds and you lose money
on that trade while watching the ES crank through highs. You can also miss
important prints and information in the order book. Signs that bids or offers are
getting stronger or weaker.
It's a trap. Sometimes it works. Sometimes it doesn't. It can't even be used as a
reverse indicator. Stocks go up, bonds go up. Next time stocks go up, bonds go
nowhere. Then bonds go up and stocks go nowhere. Then they move in a perfect
inverse fashion. Substitute any pair of markets you like. The result is frequently the
same.
If you would like to test your own ideas on this, be sure you are taking every
trade and keeping track of the win/loss rate as well as the net profit or loss which is
occurring as a result of these trades. If you would like to spare yourself a lot of time
and a negative net result, just take a word from the wise and ditch the idea
altogether.
