Market Panic Explained

There's something you should know about the Aussie dollar. It'll help you understand how investors are treating risk following last night's incredible session on the Dow.

The AUDJPY has been a risk appetite indicator since summer 2006. This popular carry trade is strongly correlated with the Australian stock indices. The Japanese currency is negatively correlated with world equity indices. Stocks go down, yen goes up. They move into opposite directions.

When investors are risk-seeking, they go long carry trades (long AUDJPY for example) where they win on both interest rates differential and FX rates. Those gains in cash are invested on the stock markets. When investors become risk-averse they cut their carry trade positions. This means they have to sell their equity lines to have some cash to face their potential losses on the currency side.

So a clear view of the FX markets can be very useful for the equity investments.
Yesterday Wall Street crashed by 6.83% for the Dow Jones and by 8.50% for the S&P 500. In the same time, the AUD/JPY fell by 5%.

The weekly chart  shows the correlation between the AUD/JPY and the $&P/ASX 200 since 2000. This correlation has been very strong since 2003 and the beginning of the bullish trend on the equity markets.

The AUD/JPY has been retracing its 7-year bullish trend.. Two first intermediary supports have been hit in March and September this year and constituted an opportunity for traders to sell back the Japanese currency. These supports were the 38.2% and 50% Fibonacci levels.

The crash today on the S&P/ASX 200 has already driven the AUD/JPY lower than 82, the 50% Fibonacci ratio. The next target is therefore around 75.50, which is the last significant correction level of the 7-years bullish trend.

The Momentum and MACD indicators are bearish. Risk-aversion is soaring. Those elements argue consequently for a further Yen rise.

Yesterday the currency pair closed at 83.51. There is another 10% decrease potential to reach the target of 75.50. Tomorrow we will have a look at the S&P/ASX 200 technical forecasts...and find out where this market is heading.