WITH the heightened risk of a Grexit, traders are looking for ideas to take advantage. One popular idea is to trade the Dax. But as we saw yesterday morning, the Dax fell 5 per cent from its Friday close. Abrupt moves like this could be the end for any leveraged trader.
This highlights the need to rotate between assets when trading a theme. Specifically, we look for markets which offer ample liquidity and the longest open hours, while remaining correlated to our theme.
Dax liquidity is high, but the market closes daily and there is a risk of a gap each day. We can gain similar exposure via the Dow, which has a daily correlation of 0.77 over the last 29 days. The benefit is the extended open hours given the widespread use of futures contracts. This allows us to avoid big gaps.
A second way to gain exposure is to trade euro-sterling or euro-dollar which, according to the experts, are expected to trade lower independent of a Greek exit. The benefits of FX markets are continuous prices and the liquidity available. Another benefit is the fairly constant volatility across bearish or bullish trends.
In the case of stock markets, volatility studies show that positive returns do not necessarily feed higher negative volatility. In the case of a stock market downtrend, volatility increases on both sides, meaning that we get strong declines and rallies in a downtrend. This makes it easy to get shaken out of a bearish stock market.
While the FX markets and the Dow are good substitutes, unfortunately they do not cover for weekend gaps. Yet they allow us to manage our risk throughout the week.
Alejandro Zambrano is a currency strategy analyst at DailyFX. firstname.lastname@example.org