How markets operate.

Example:
Flight to reserve currency lends strength to the dollar, yes.

Does this dollar strength lead to declining stock prices as the market assesses relative value in dollar terms or does the stock price just fall because the economy falters?

I guess what I'm trying to understand is the degree of independence that each market has from another.
Is price determined by the flow of money into and out of different assets or is it some sort of fair value adjustment and the bid/ask changes with the outlook? Are those two events mutually inclusive?

The further I get into writing this thread the more I realise that I'm lightly touching on a million different subjects and not really asking one clear question lol.
I'll post it anyway. Maybe get some good discussion and will be interesting to find out what you guys think

It's a great puzzle, innit? I don't know the answer or, rather, I think the answer is that the direction of causality is unstable.

Martinghoul said:

I think the answer is that the direction of causality is unstable.

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Probably. It's a nightmare innit lol.

Im trying to get some idea on how it all fits together. From what I read, the biggest mover of a currency is interest rates, the higher the rate, the stronger the currency. (Strictly speaking its the differences between the currency pairs). Next comes economic growth, so if USA is growing people will invest in stocks etc and so will have to buy dollars to do so - strengthening the dollar, all else being equal.

What I dont get is yesterday the news seemed to indicate that USA was growing slowly, the stockmarkets dropped but yet the dollar is rallying. The EUR/USD dropped quickly but why? Same with Eur/Gbp - it dropped meaning buying pounds? but the news for GB was bleak yesterday?

Well, apart from the factors you've listed, there's also just plain fear. When it's "risk-off" time, everyone wants to own stable reserve-like ccies. Hence, dollar and yen strengthening.

Seeing how you're in here MG, it's unrelated to topic but erm what do they use for the risk free rate in the real world? Does it differ by country?

Back on topic... I can't believe that I spent a year bouncing around before even hearing or considering the concept of "risk off" etc. It really helps you understand a lot about the way things move.

scose-no-doubt said:

Example:
Flight to reserve currency lends strength to the dollar, yes.

Does this dollar strength lead to declining stock prices as the market assesses relative value in dollar terms or does the stock price just fall because the economy falters?

Click to expand...

In a flight to quality situation, money leaves risk assets (stocks, commodities) and flows to preceived safe assets (dollar, Treasuries). That is why stocks fall, oil falls, Treasury rates fall, and the dollar rises.

I guess what I'm trying to understand is the degree of independence that each market has from another.

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It varies, even intraday. I've seen days where the market has gone from being fundamentally/news driven to trading off risk aversion in a very short span. Generally speaking, currencies and interest rates are fairly closely linked in a positive fashion (rates up, currency up). Under risk aversion, though, things change.

Is price determined by the flow of money into and out of different assets or is it some sort of fair value adjustment and the bid/ask changes with the outlook? Are those two events mutually inclusive?

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Price is always determined by the action or inaction of market participants. Full stop. The fair value adjustments, such as they are, come about because of the orders and trades put through by traders. For example, XYZ stock may have a percieved fair value at 100. If no one is willing to pay that much for it, however, it's not going to trade at 100.

By fair value I mean price traded at, Rhody. Does the bid ask instantly change according to value or does the bid/ask change as a result of the flows in and out?

Hello lurkers.

scose-no-doubt said:

By fair value I mean price traded at, Rhody. Does the bid ask instantly change according to value or does the bid/ask change as a result of the flows in and out?

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Traded price is a function of the bid/ask. The bid/ask is where market participants are looking to transact right now. The two may not be the same at any given point in time. The bid/ask will change if new orders come in or if old olders are either filled or pulled. Market makers move their bids/asks around trying to maximize order flow (which is how they make their profits), so they will tend to move toward the level at which there is the most buy/sell interest. That interest will be heavily motivated by flows. So the answer is yes, that the bid/ask does changes as the result of flows.

I've been wondering on the same lines, i was prompted by something that is perhaps relevant.

When evaluating a stock, you look at the cost of capital. The cost of debt is the cost of debt and is easy to work out in most cases. The cost of equity depends on the risk-free rate, beta and the risk premium. This is far more interesting. I use the 10yr treasury as my risk-free rate and of course this led to strange outcomes recently. (Before anyone says anything, I know cost of equity is useless.) This raises an interesting point though about asset flows because it implies a cost of capital in some cases of 5% or even 3% which isn't a high barrier.

Basically, my point is that an inelastic demand for liquidity at any price seriously ****s things up and I would say leads to a move away from "fair value", in most markets. The question is though is something like the 10-yr representive of a demand for liquidity? The move in the $ is interesting as well, the implication being that this isn't a flight to quality. Just something I found interesting though...

Another point relating to asset flows is the respective movements in government bonds and currencies. I have a few ideas but I don't understand why there is a seemingly fairly strict negative correlation in periods?

cr6196 said:

The question is though is something like the 10-yr representive of a demand for liquidity?

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Dont get this bit

i mean how much is it viewed as a money-equivalent.

scose-no-doubt said:

Example:
Flight to reserve currency lends strength to the dollar, yes.

Does this dollar strength lead to declining stock prices as the market assesses relative value in dollar terms or does the stock price just fall because the economy falters?

I guess what I'm trying to understand is the degree of independence that each market has from another.
Is price determined by the flow of money into and out of different assets or is it some sort of fair value adjustment and the bid/ask changes with the outlook? Are those two events mutually inclusive?

The further I get into writing this thread the more I realise that I'm lightly touching on a million different subjects and not really asking one clear question lol.
I'll post it anyway. Maybe get some good discussion and will be interesting to find out what you guys think

Click to expand...

i read regularly but don't post, but i feel compelled to say this scose;

you are completely over-egging it.

it's great to understand the markets and how they move and to be able to talk people to death with rationale for the day's moves in retrospect, but if you're looking to trade the market as opposed to theorise about it, do this:

if something is going up, buy it.

if something is going down, sell it.

if you trade at levels where you will quickly know if you are wrong - retraces to support/resistance in an up/downwards trend, and let the trades run when they go your way, over time you will make a lot more money than by trying to work out every fundemental intricacy of every market.

pick a product, do what the market is doing and control your risk by entering sensibly. the rest is just CNBC/broker chatter. you don't need it.

regards.

so changing yield as a proxy for demand? :S

shortsell said:

i read regularly but don't post, but i feel compelled to say this scose;

you are completely over-egging it.

it's great to understand the markets and how they move and to be able to talk people to death with rationale for the day's moves in retrospect, but if you're looking to trade the market as opposed to theorise about it, do this:

if something is going up, buy it.

if something is going down, sell it.

if you trade at levels where you will quickly know if you are wrong - retraces to support/resistance in an up/downwards trend, and let the trades run when they go your way, over time you will make a lot more money than by trying to work out every fundemental intricacy of every market.

pick a product, do what the market is doing and control your risk by entering sensibly. the rest is just CNBC/broker chatter. you don't need it.

regards.

Click to expand...

When did I ever say any of this was related to trading?

Why don't your read the OP again.

i just assumed that as this is a trading forum your posts were related to trading.

you also first posted accepting my point and have now edited to feign offence, which is odd.

the reason for my post is that you seem to be posting questions every 5 minutes that you may well have a genuine interest in, but the answers to which aren't going to make you any money.

if you are interested in making money from the financial markets as a retail trader, the simpler the better, trust me.

anyway, i am not here to upset you and probably won't be posting again after today - i think it was a couple of years since my last contributions - so feel free to ignore me and continue your quest for profitless knowledge.

all the best either way.

My conclusion (at which I have arrived after the crisis years) is that there isn't really such a thing as a risk-free rate. It's a helpful shortcut that people used to evaluate things, because they simplistically assumed there's uniformity in the mkt (basically, 'cause they were lazy). in reality, what matters is not the risk-free rate, but rather your funding rate. That's the real cost of capital that should be used whenever investment decisions are made. Obviously, to be able to understand mkt prices, you also need an idea of what your mkt counterparty's funding rate is. That's all there is to it, IMHO.

And, by the way, I don't think a better understanding of how mkts work can ever be considered "profitless knowledge".

My first unedited post was an attempt to avoid another of my threads turning into a flame-fest but I decided I'd rather post what I think and suffer the consequences.
I wasn't offended I just stated you should read the post again.
If you want to act like a smarmy know-it-all then that's your business, feel free but please don't presume to know anything about me or why I use T2W.

Thanks for the concern

Sco

whatever i know it is a far way from "it all" sir.

you seem very defensive. i'll leave you alone.

if it suits you to do so, think about what i said though. currently it's unlikely you make money trading. you could do so easily by cutting back all the nonsense and keeping it clean and simple. alternatively you could continue on the same path, never make a penny fom the markets, and dismiss my genuine attempt to help as the presumptions of a smarmy know-it-all. it won't impact me either way, but if you consider what i've said rationally it could genuinely save you years - and potentially a lot of cash.

i hope you get very rich and are very happy.