 |
|
Forex Trade Market links
Basis and Correlation of Forex
"Basis" refers to the difference between two prices forex market. Basis is central when spreads and hedges are entered. When someone talks about basis, it is taken for granted that he or she is referring to markets of related products, with prices that move in tandem (i.e., correlate) but the term does not necessarily imply a price correlation. It is meaningful, for example, to speak of the basis between Swiss francs and Deutsche marks, or Chicago wheat and Kansas City wheat, or the S&P 500 index and the Value Line index, but we can just as easily talk of the basis between Deutsche marks and Japanese yen, or gold and British pounds, or coffee and copper. The basis simply refers to the difference in price between any two things for which values can be assigned.
Correlation
Correlation is measured as a coefficient between a 1.00. A zero coefficient denotes random movements of the two prices relative to one another; 1.00 signifies prices moving in perfect lock step. Figures 4-3 through 4-5 show two price charts for each pair of markets. The upper chart of each pair shows individual price moves. The lower chart shows the price of one market held constant at zero value, and the price difference of the second market is plotted against this constant. This is known as a "basis chart." Basis is often referred to as a premium or a discount to the base line. Markets Band D, for example, is trading at a discount.
|
|
|
 |
|
|
Base Currency
 Base currency is the currency in which an investor or issuer maintains its book of accounts. In the FX markets, the US Dollar is normally considered the 'base' currency for quotes.
|
|
Technical Analysis
 An effort to forecast prices by analyzing market data, i.e. historical price trends and averages, volumes, open interest, etc. |
|
|
 |
|
It's normally condensed as the dollar sign, $. The U.S. dollar is divided into 100 cents.
The euro is the currency of 13 European Union countries.
|
|
|
Under forex trade of FX market, The Basis between Markets A and B shows a high degree of correlations, with a coefficient well above 70%; therefore, these two markets are suitable for hedging purposes. Note that there can also be a high degree of negative correlation, such as with Markets C and D. Although mirror images of each other, the correlation is perfect, with a coefficient of 1.00. Markets C and D can provide nearly perfect hedges. Reverse position hedges are used for negatively correlated markets.
Assume, for example, that Market C represents the yield of a U.S. treasury bill in the cash market, and Market D represents the price of a futures contract for the same bill. They maintain a perfect negative correlation; an up tick in yield is a down tick in price. If a hedger were long short-term interest rates, he would go long Treasury bill futures. This, of course, is the opposite of a normal hedge, where a long exposure requires a short hedge position. In this case, however, the loss from a drop in interest rates is offset by a gain from the higher futures price.
Basis charts can be drawn for any two markets. If one were to measure the price relationship between feeder cattle and gold, Market E might be the value of 100 ozs, of gold over time, and Market F might be the price of feeder cattle over the same length of time. Most likely, the correlation coefficient would be zero!
Obviously, even in so-called parallel markets concept FX Concept the price basis can be a wildly changing affair. One day it may be "narrow," meaning that the differences in prices are small. The next day the basis can be "wide," with prices far apart. If the markets do not relate to each other, the basis is often completely random. In fact, parallel markets are identified simply by analyzing the price basis between them. Where there is a correlation, there may be a parallel market. Basis is charted using historical price data, much as is done when working with exchange rates. What is most interesting is evidence of predictability in the correlation analyses. If there are two items with prices moving together in a highly predictable fashion over a significant period of time, they are not only parallel markets, but hedge able parallel markets.
When are two markets highly correlated enough for hedging purposes? In general, if the correlation is 0.70 or higher, there is a good chance that the two markets can be used to construct a hedge; therefore, the definition of a hedge can be refined again as follows:
Hedging means off-setting a given position by taking an equal and opposite position in a separate but parallel market. The effect of the offsetting position is to reduce or eliminate the effects of changes in the value or rate of both positions. Markets are sufficiently parallel if the correlation coefficient of the basis is 0.70 or higher. |
|
 |
|
