The lull between when the US markets close and the local market opens can be a lucrative time to put on positions, but don’t just expect the Australian index to follow New York.
If the US market has fallen overnight, it’s an easy trade to open a short CFD (contracts for difference) position on the Australian index – right? After all, if the US catches cold, the rest of the world sneezes.
Wrong, because sometimes the Australian index will move to the beat of a different drum.
“Over the past few months, I would say, on rough-and-ready figures, that the number of times when the Australian market opened in the same direction as the US market closed has actually been in the region of 50-60 per cent,” says Ric Spooner, strategist at CFD provider CMC Markets.
“If you take a hard look at it, I’m not so sure that the response of the Australian market to US trading is as slavish as people assume. So I’m not so sure that a strategy based on a mechanical following of what has happened in the US is necessarily the way to go.”
The US market is still the major influence on the Australian share market, says Spooner, but there are other influences emerging. “Obviously the US economy is the largest economy in the world by far, notwithstanding the growth of China, and so what happens there in terms of economic statistics has a significant leading impact on our market and all markets around the world. The mood, the tone, for the world’s markets is set by New York as a consequence.
“But only up to a point as far as Australia is concerned. The things that make our different include the composition of our market: we have a very big weighting to the resources and financial sector, so our market is very cyclical in its behaviour. Secondly, the currency plays a big part, and certainly in terms of what’s going on in our market for overseas investors, what happens to the A$ affects Australian valuations a lot. What they do in our market will be influenced by currency moves.”
Another thing that increasingly makes us behave differently during the day, he says, is news from China. “As China grows, the instances in which news out of China leads the tone for the world will increase. That news – economic statistics – tends to break at around 1:30 pm eastern Australian time.”
Spooner says a trader looking to trade the “handover” from the US market to the Australian open should in fact look firstly for reasons why the Australian market could take a different tack. “For example, BHP makes up about 12-15 per cent of the value of the ASX 200. One of the more common reasons for our market behaving differently to the US market is the times when BHP is doing something a bit differently.
“That can be because of news from China, for example. But it helps to look at what BHP’s ADRs (American Depositary Receipts) trading in New York (one BHP ADR represents two BHP shares) and have done overnight. If you can see that BHP has strongly reinforced the US market, then you might want to join that direction when our market opens.
“But on the other hand, if BHP closes up in New York when the US market has closed lower, that’s the sort of instance where you might think that what people assume about the Australian market for the following day might not turn out to be the case,” says Spooner.
Michael McCarthy, head of dealing, Asia-Pacific, at CFD provider City Index, says the activity of customers around the time of the handover is increasing, in both index and foreign exchange CFDs.
“We’re seeing a lot of customers getting active around that time of the handover. The main trade we’re seeing in the index CFDs is a pairs trade, where you’re looking to trade relative performance. For example, traders will look at the impulse in the US market on the day, and where it finishes versus that impulse, and then look to position themselves in the S&P 500, looking for an over- or under-reaction in the Australian market against that move.”
In a pairs trade, the trader takes a long position and a short position simultaneously, seeking to profit from relative performance. Whether the market rises or falls is irrelevant: it’s the relationship between the pair of securities that matters to the pairs trader. As long as the trader buys the outperformer and sells the underperformer, the trade will make money.
“Say for example traders have seen a strong day in the US, it finishes reasonably well and they’ve positioned themselves long in the S&P 500. They will then look for the reaction in the Australian market, and often we see that it will open up 1-1.5 per cent, and they will then short the Australian market against the S&P 500 position – with a view that that impulse has reflected all of the overnight news, and the risk then clearly shifts to the other side. It’s taking advantage of the moves at the handover, to put on a good relative-value trade. We are certainly seeing increasing activity in that,” says McCarthy.
The same kind of thing is happening in the foreign exchange market, he says. “The period between the New York close at 7 am and the Tokyo opening at 10 am is a flat period. There is a bit of activity from New Zealand, but that is not a major influence. During that three-hour window the market is relatively illiquid and there is no reason for large players to be in the market at that time. But it means that the currency can jump around in that time on no news, and for small traders, particularly CFD traders, there is the opportunity either to get on to a trend on a pullback or to take advantage of a temporary aberration in prices.”
Not only the A$, but the European currencies can also “flick around” in that flat period, says McCarthy. “When the European markets are closed, we often see the European pairs – not so much €/$US, but say the Swiss franc, or the Norwegian kronor, and even cable (the $US/£ cross) – moving on little or no news. That could simply reflect a small order going through and a lack of participants at that time. For individual CFD traders, that represents an opportunity – because as soon as the larger markets awaken and the traders in Sydney and Tokyo get on to it, they’ll bring it back into line pretty quickly in most cases.”
Taking advantage of the pricing aberrations that occur during the flat period between New York closing and Tokyo opening is not a strategy that an investment bank prop (proprietary) desk would use, says McCarthy, because there is not enough liquidity for them to do it in a size that makes it worthwhile. “The institutions would be doing their foreign exchange market in the over-the-counter (OTC) market, they wouldn’t be bothering with CFDs. But that’s why there is an opportunity for CFD traders,” he says.
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