As anyone that’s been following Jigsaw for a while will tell you – we love correlations. Correlations exist in markets because of arbitrage trading that simultaneously buys and sells correlated markets to make a profit when they come back in line.

Now, it’s a bit of a catch 22 because correlations are reliable because of arbitrage. Why does the arbitrage trade work – well, because of correlations of course! You can worry which is the tail & which is the dog or you can observe how they operate and trade them with confidence based on your observations.

Correlations are not 100% consistent. In fact, the inconsistencies and breakdowns in correlations help us to identify shifting market states. For today though, we are going to look at trading divergences. When one market is moving but the other is not co-operating. In this video from Axia Futures We see a unique trading opportunity that occurs when correlated equity market indices diverge while the price ladder order flow supports a likely reversion. This example shows how the Eurostoxx market had been displaying a lot more strength than the Dax and how when the Dax made new lows, Eurostoxx held within its range.

Richard explains that if a correlated market like the Eurostoxx isn’t supplementing the Dax’s move lower, it can be seen in a way as drag on the Dax that pulls it back up. Looking at how this plays out on the price ladder reveals more detail into the weakness of the Dax’s offer down. As long as Eurostoxx wasn’t breaking its low and the Dax had no pickup in selling activity, this could be seen as a valid buying opportunity.

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