How Divergences Between the Australian Dollar and the S&P 500 Can Signal Trades

(This is an excerpt from an article I originally published on Seeking Alpha on July 8, 2012. Click here to read the entire piece.)

I have written several articles now discussing the dynamics of the Australian dollar as well as its correlation with the S&P 500 (SPY). At the end of May, I wrote “Correlations Are Broken But Australian Dollar Still Leads The S&P 500” and demonstrated how the decline in the Australian dollar versus the U.S. dollar (FXA) in March potentially provided a leading indicator of the eventual peak of the year for the S&P 500. Friday’s trading showed once again how traders might be able to use divergences between the Australian dollar and the S&P 500 to guide short-term trading.

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The U.S. dollar index is again pressing against QE2 resistance and now looks ready to break it
The U.S. dollar index is again pressing against QE2 resistance and now looks ready to break it

Although the U.S. dollar index remained strong into the close, the Australian dollar rallied strongly into the close. In fact, while the S&P 500 made a new low for the day ahead of 2:30pm, the Australian dollar (against the U.S. dollar) did not. This divergence, a bullish divergence, may have served the attentive trader well on Friday no matter what explains the closing rally. Going forward, I am certainly going to monitor weekly, daily, AND intra-day divergences between the Australian dollar and the S&P 500. In the chart below, the thick red line represents the Australian dollar versus the U.S. dollar in foreign exchange (AUD/USD) and the black (jagged) line represents the S&P 500. The black horizontal line represents the Australian dollar’s low for the day.


The Australian dollar fails to make a new intra-day low when the S&P 500 prints its fresh low on the day
The Australian dollar fails to make a new intra-day low when the S&P 500 prints its fresh low on the day

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S&P 500 turns away from resistance at the 2011 high
S&P 500 turns away from resistance at the 2011 high

Source for charts: FreeStockCharts.com

Be careful out there!

(This is an excerpt from an article I originally published on Seeking Alpha on July 8, 2012. Click here to read the entire piece.)

Full disclosure: net short Australian dollar, long SDS

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