The correlation between any two variables (or sets of variables) summarizes a relationship, whether or not there is any real-world connection between the two variables. The correlation coefficient will always be between -1 and +1. These two extremes are considered perfect correlations. A negative coefficient means that the two variables, or sets of variables, will move in opposite directions (if one variable increases, the other will decrease); a positive coefficient will mean that the two will move in the same direction (as one increases, the other will increase).

If we compare the US Dollar Index (USDX), an index that tracks the value of the U.S. dollar against six other major currencies, and the value of the Dow Jones Industrial Average (DJIA), Nasdaq and S&P 500 over a 20-year period, the correlation coefficient calculated for the USDX versus the DJIA, Nasdaq and S&P 500, is 0.35, 0.39 and 0.38, respectively. Note that all of the coefficients are positive, which means that as the value of the U.S. dollar increases, so do the stock indexes, but only by a certain amount. Notice also that each coefficient is below 0.4, which means that only about 35% to 40% of the stock indexes' movements are associated with the movement of the U.S. dollar.

A country's currency can become more valuable in relation to the rest of the world in two main ways: when the amount of currency units available in the world market place is reduced (for example, when the Fed increases interest rates and causes a reduction in spending), or by an increase in the demand for that particular currency. The fact that an increase in the U.S. dollar affects the value of American stocks seems natural, as U.S. dollars are needed to purchase stocks.

The value of American stocks, especially those that are included in market indexes, tend to increase along with the demand for U.S. dollars - in other words, they are positively correlated. One possible explanation for this relationship is foreign investment. As more and more investors put their money in U.S. equities, they are required to first buy U.S. dollars, which can be used to purchase American stocks, causing the indexes to increase in value.

For more insight, see Commodity Prices And Currency Movements and Using Currency Correlations To Your Advantage.

  1. How is the value of a pip determined?

    A pip in foreign exchange trading is a measure of a price movement in a currency pair. "Pip" is an acronym for price interest ... Read Full Answer >>
  2. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  3. How are NDFs (non-deliverable forwards) priced

    The price of non-deliverable forward contracts, or NDFs, is commonly based on an interest rate parity formula used to calculate ... Read Full Answer >>
  4. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  5. What is the difference between a Nostro account and a regular bank account?

    The term nostro account is a bit of an umbrella term and can have different meanings for different contexts. For instance, ... Read Full Answer >>
  6. What types of companies benefit from reporting results utilizing constant currencies ...

    Any company that does a substantial amount of business in foreign countries, and is therefore subject to foreign currency ... Read Full Answer >>
Related Articles
  1. Investing

    How to Spot Secular Bull Markets vs. Secular Bear Markets

    A guide to identifying secular bull and bear markets.
  2. Forex Education

    Explaining Uncovered Interest Rate Parity

    Uncovered interest rate parity is when the difference in interest rates between two nations is equal to the expected change in exchange rates.
  3. Forex Education

    Top 6 Most Tradable Currency Pairs

    The most frequently traded currency pair is the euro/U.S. dollar. The euro is the base currency in the pairing, while the dollar is the quote currency.
  4. Forex Fundamentals

    How to Buy Chinese Yuan

    Discover the different options that are available to investors who want to obtain exposure to the Chinese yuan, including ETFs and ETNs.
  5. Markets

    What Slow Global Growth Means for Portfolios

    While U.S. growth remains relatively resilient, global growth continues to slip.
  6. Economics

    Will a Hike in Interest Rates Affect the US Dollar?

    Learn about how rising U.S. interest rates affect the U.S. dollar and where the dollar could be heading once the rising rate cycle begins again.
  7. Economics

    How Bitcoin Helps People Bypass Government Currency Control

    Bitcoin has helped ordinary citizens in some countries bypass government controls over free exchange conversions.
  8. Forex Education

    9 Tricks Of The Successful Forex Trader

    These steps will make you a more disciplined, smarter and, ultimately, wealthier trader.
  9. Economics

    What Bitcoin Regulations Look Like Around The World

    Bitcoin is still so new that countries are struggling to make legislation catch up with technology. Some nations are more open to virtual currency than others.
  10. Mutual Funds & ETFs

    An ETF for Dollar Bulls: PowerShares UUP

    A look at PowerShares US Dollar Index Bullish Fund ETF.
  1. Currency

    Currency is a generally accepted form of money, including coins ...
  2. Futures Market

    An auction market in which participants buy and sell commodity/future ...
  3. Benchmark

    A standard against which the performance of a security, mutual ...
  4. Capital Markets

    Capital markets are markets for buying and selling equity and ...
  5. Equity Market

    The market in which shares are issued and traded, either through ...
  6. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...

You May Also Like

Hot Definitions
  1. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  2. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  3. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  4. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  5. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  6. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
Trading Center