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Global Capital Flows

Posted: 2019-May-03 13:01 by Paradigm

The purpose of this post is to engage people in discussion about what really makes capital funds flow from one market to another.
[b] [quote]“Like right now, I'm watching the currencies, I'm watching Crude, I'm watching Stocks and Bonds, they're all interrelated, the whole world is simply nothing but a big flow chart for Capital.” ~ Paul Tudor Jones [Trader, The Documentary][/b][/quote] In order for me to have confidence in a process, it is important to me that I understand how that process works, i.e. it isn’t enough for me to simply say: When event / scenario / environment X is playing out, market Y will sell off and market Z will rally, so just go ahead and either sell market Y or buy market Z.

For my own peace of mind I NEED to be able to explain WHY and HOW market Y and market Z are reacting to event / scenario / environment X. I know that this is not always possible with every facet of the market, but where possible, I need an answer - that’s just part of my psychological profile.

For this reason I would like to explore and expand on the topic of Global Capital Flows.
I do not yet understand this process, and so I put forward for discussion this post, for others to either confirm or deny its content, or to otherwise contribute as they see appropriate.

[b]A bit about the subject:[/b]
The following information is largely a collection of sources that I have gathered (at times verbatim) over time from all over the internet. Where possible, the origin of the work will be credited and cited, but unfortunately many times I neglected to take note of the source of the information. If you think that some of your work is listed below and I have not cited it, please let me know and I will do so.
I am in no way trying to pass the below information off as my own thoughts or work, I am simply trying to gather all the relevant information I can find together in one place, so as to form a coherent post that will hopefully incite intelligent discussion.

Savvy, experienced and knowledgeable traders more than likely won’t find anything useful or new in here. If you fall into this category you can probably safely stop reading now. This document is aimed more at people like me – those who have a technical background, but who are relatively new to the Fundamental / Sentiment side of things, and need help trying to piece it all together as to how money moves around the different markets, as opposed to just looking at one particular market and trading that markets price action.

My ultimate goal from this post would be to end up with a peer reviewed model or flow chart / decision tree that could be referred to as a high level, logical reference for identifying trading opportunities in the various markets, relative to the current economic environment, so that high level trade decisions could be made accordingly.


If requesting a correction, please mention the section that you want corrected, and an explanation as to why you want it corrected.

If references are missing, please request them to be added.

If you know of missing content / theories / processes that would help explain the processes outlined in this document better, you can help by adding the relevant information in reply posts, for each referring item.

Comments are welcome, but please note that I am very new to the Fundamental / Sentiment side of things, and may not be able to answer some / any questions if further explanation is required, I am however, happy to try.

Posted: 2019-May-03 13:06 by Paradigm

[b]Inter-Market Analysis[/b]

When discussing Inter Market Analysis, it is important to remember that different markets may not move in a 1:1 correlation, as all markets have their own fundamental reasons for moving individually.

The price of a commodity can affect the value of a currency.

In order to purchase Gold or stocks, you need the local currency to make that purchase, in the case of Gold or Stocks in the S&P500, this is the US Dollar. Domestic currency (buyer’s money already denominated in USD) doesn't need to be converted into anything in order to buy Gold or shares on the S&P500. International funds coming into the USA however, do need to be converted into US Dollars. That means selling the international funds local currency and purchasing US Dollars in order to buy the Gold and the S&P500 as part of the transaction. This influx will cause a corresponding rise in the value of the US Dollar. The reverse is also true. Poor performance of the US stock markets will see capital flight and a corresponding drop in value of the USD.

If a country’s main Export is Oil, and there is a drop in the price of Crude Oil, then that currency will devalue. This is because the demand for the commodity has dropped, in a combination of active selling and exiting long trades. This creates supply (selling) pressure on the currency as they exit longs and enter short positions, driving the currency down. Australia is a commodity based economy; specifically based on Gold; Canada produces Crude Oil, and New Zealand produces Gold. If the value of Gold drops; it is going to affect the Australian and New Zealand economies and the value of the currencies.

Big Money like Hedge Funds, Investment Banks, and Companies are almost always seeking the highest return on their investment money. Big Money will move their money from one country to another to chase the highest return, and this effects the value of the currency for that country.

Equities markets are essentially stocks listed on certain Indexes, S&P500, Dow Jones, NASDAQ etc. and are considered very risky markets with potentially high returns. If the Dow Jones is rallying for example, that signals that the top 50 companies in the USA are doing well, and this is a measure of the economy.

If the Equities Market is rising in a country, this will attract international investment money. This is called Risk Appetite (Risk On - traders are willing to take more risk) because Equities trading is considered much riskier than investing in Government Treasuries Bills (T Bills or T Notes) or the Bond market.

Posted: 2019-May-03 13:13 by Paradigm

[b]Risk On / Risk Off (RORO)[/b]

Risk on / Risk off describes the current market sentiment as being either Optimistic or Pessimistic.

Risk Aversion (Risk Off) - During an Economic Downturn or a Fearful period, traders are not willing to take risks. During Risk Off, the market is pessimistic and will stay away from the perceived riskier markets in favour of the perceived lower risk of “Safe Havens” such as Bonds, the US Dollar, the Japanese Yen, the Swiss Franc, Government Bonds and (sometimes) Gold. Traders are looking for safe, stable investments during this time.

Government Bonds are considered safe because the Bonds are issued by the Government and the Government indirectly has the ability to order the printing of money to pay back the bond, which is essentially an IOU issued by the Government.

During periods of Risk Off Economic downturn, traders are careful and only want safe investments, so pull out of Equities and put their money into Bonds. This creates demand for the Bonds, and demand causes prices to rise.

The Interest paid on the Bond is called Yield. Bond yields are set high as an incentive, so as to attract investment money to a high rate of return. As demand comes into the Bond market, and Bonds are purchased, the Yield on the Bond falls. Thus, there is an inverse relationship between the price of Bonds and the Yield.

During a period of Risk Appetite Risk On traders will leave the Bond market to trade products with a higher rate of return, such as Equities, and the prices of the Bonds drop as demand leaves the market. In order to attract money back into the Bond market, a Government can and will set the price of the Yield higher to attract investment money into the Bond market.

If however traders do not think that economy of that particular country is doing well, or do not trust that the Government can pay back the Bond for whatever reason, then despite the higher Yield, they will move their money out of that country and into a Safe Haven in a process that is known as a Flight to Safety, in which they will invest in a safe stable environment that they have faith in, such as the US Dollar or Gold.

So it is not always about absolute Yield or rate of return, if there is little or no trust and traders fear they will lose their capital, such is the case in Spain at the moment with the Euro Zone bailouts.

So how does this play out if US Treasury Bonds are only paying a low Yield such as 2%?

Using the above example of Spain, if people move to the US Dollar, that means they will be moving away from the Euro - a move that will see the Euro drop.

The smart trade here would be to sell the Euro and buy the dollar, i.e. short EUR/USD In order for large market participants to buy US Bonds, the purchase process requires them to convert their local currency into USD to buy the Bonds, and so this will see the US Dollar rise as well.

When structuring a trade you should look at buying the strongest currency and selling the weakest currency. For example if people are buying Gold as a Safe Haven, the AUD will rise as it is closely linked to Gold as a commodity currency as a major Gold producer, and if the UK releases poor GDP data then that is bad news for the UK / GBP. If you wanted to take advantage of the above process of people moving into the US Bond Market as a currency trade, you wouldn't want to trade the AUD as it is getting stronger, as Gold is also a Safe Haven, but you could short sell the GBP as it would fall on negative GDP news, so you short GBP / USD and take advantage of both the falling Pound and rising Dollar.

[b]The best way to determine what Global Flows are going to do is to look at what they have already done in the past, and WHY they did what they did. Even if the flows themselves change, understanding WHY the flows move and what influences them, you should be able to figure out any changes to the flows. If the environments are strong enough, and persistent enough, they might then produce trends that can be traded on a longer time frame.[/b]

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