Friday, January 23, 2015

Statistical Correlations, Cause and Effect, and Markets Dancing with each other

It is widely known that relationships between currency pairs and the S&P 500 exist. Between commodities like OIL and the S&P 500. But oddly, these relationships seem to come and go as though the S&P 500 is like a person, who is focusing on one thing or another at any given moment, influencing their "mood".

In fact, the truth may be not too far away from that idea. Consider this. If the S&P was a person, it would not be a individual but the sum of all individual traders. A market. The market REALLY DOES focus on one thing or another at particular times, either due to media attention on something in particular, fads and obsessions of humanity, or perhaps because one market really does matter a great deal fundamentally to another for a period of time.

How does this work? Sometimes, an extreme event or price action will "kick off" a new PHASE of price movement on two markets simultaneously. When this occurs, those two markets can "get in sync" with each other, and although their price-pattern development is different, there is a certain time step.

In a manner of speaking, the markets are DANCING with each other. What is a Dance? To understand dance requires understanding music. Music is performed in a rhythmic pattern -- time. Markets also express themselves over time. As long as the pattern goes on in the market "leading" the dance, the other market who's attention is focused on the first "leading" market will follow the rhythms of the leading market, until either the leading market ends the pattern or the following market ends a pattern of the appropriate "Degree".

However, that does not mean they will behave identically, or even similarly, just as the two partners in a dance do not and are not supposed to behave identically. Each partner has a role to play. In markets, as in Dance, there may be more than two partners Dancing.

This is why statistical correlations in markets exist, develop, mature, and then break. Statistical correlations exist only so long as the Dance goes on.

As soon as EITHER partner decides their dance (Pattern) is over that began the dance, the statistical correlation is changed irrevocably, and a new dance begins.

This is why statistical correlations are the effect of market patterns, and not the cause. A market jumping into and out of statistical correlation is a function of the dances (patterns) of two or more markets beginning and ending the dance as a Simultaneous Occurrence.