Chapter 17. Stock Exchanges and Stock Indices

Despite the fact that the subject of Forex Arena information portal is Forex training, in this chapter we will consider stock exchanges and stock indices. At first glance, it may seem that the material in this chapter has nothing to do with Forex, but in fact it is not so. Exchange rates on the world currency market have correlation (interrelation) with stock indices, so the study of the latter can become a good tool in your arsenal of means of analysis and forecasting on Forex.

 

Before getting acquainted with the main stock exchanges, we will look at the participants of the stock market in order to better understand its organization. In the previous chapter we have already found out that the stock market is where securities are traded. Securities are issued by issuers – enterprises and organizations that raise money to organize their business processes. Investors who have free cash invest it in securities in order to gain profit in the future. Brokers are professional financial intermediaries licensed for this type of activity – they help buyers and sellers of securities to find each other to conclude mutually beneficial transactions. Brokers carry out their activities at the expense of their clients and on their behalf, receiving remuneration in the form of commissions when concluding a deal. The place of trading in securities is stock exchanges. These include stock exchanges and over-the-counter trading systems that allow trading using electronic trading terminals. Accounting of securities of the issuer and their current owners is carried out by a special organization – registrar. The securities portfolio of an individual investor is accounted for in the depository it is serviced by. As in any other kind of business, there are state regulation and control bodies, consulting and information firms in the stock market.

So, trading in securities is conducted on stock exchanges (exchanges and over-the-counter trading systems). The main volumes of stock trading on a global scale are concentrated on two trading floors:

NYSE (New York Stock Exchange) – New York Stock Exchange;
NASDAQ-AMEX is a combination of NASDAQ (National Association of Securities Dealers Automated Quotations) and AMEX (American Stock Exchange).

In addition to the above trading floors, special attention should also be paid to:

LSE (London Stock Exchange) – London Stock Exchange;
TSE (Tokyo Stock Exchange) – Tokyo Stock Exchange;
DB (Deutsche Boerse) – Frankfurt Stock Exchange;
SEHK (Stock Exchange Hong Kong) – Hong Kong Stock Exchange.

We will not dwell on what affects stock prices in the long term, as it may take a long time to consider this issue. Nor will we go into detail about the classification of company stocks by industry. We will only say that there are several industries, each of which is attractive to investors in its own way. When investing money in the shares of a company in this or that industry, the fact remains unchanged that greater profitability means a greater risk of loss for the investor. The topic of analyzing the financial performance of a company in order to make investment decisions is also beyond the scope of this site. But it is necessary to know that there is a quantitative analysis of the indicators of financial statements (quarterly, annual) and a qualitative analysis of the policy pursued by the company’s management.

Now let’s focus on what correlation (relationship) exists between the Forex currency market and the stock market. We already know that the exchange rate of a currency directly depends on the state of the economy of its country. The state of a country’s economy depends on many factors. The generalizing indicator of these factors is the gross domestic product – GDP. There are several methods of calculating GNP. Within the framework of the material we are considering, it is only necessary to understand that the better the financial position of companies representing the key industries of the state (the higher the share prices of such companies on the stock market), the higher the GNP and the more stable the currency. This means that if the shares of companies representing key industries of the state grow in value, the currency of this state grows in value on the Forex market.

Thus, the question remains open – how to quantitatively determine the state of the stock market of a particular country. Special indicators – stock indices – were introduced just for this purpose. Each stock exchange uses its own stock indices, which characterize the state of the stock market of its country. The value of stock indices is calculated on the basis of the value of shares of companies (in a certain proportion) included in the calculation base of the index. Despite the fact that there is a variety of stock indices, each trading floor is used to allocate only the most important ones, which most closely reflect the state of the stock market and the economy of their country. Let us list the main stock indices:

DJIA (Dow Jones Industrial Average – the Dow) in the United States;
NASDAQ Composite (National Association of Securities Dealers Automated Quotations) in the USA;
S&P 500 (Standard and Poor’s 500 Index) in the USA;
FTSE-100 (Financial Times Stock Exchange 100 Index) in the UK;
DAX (Deutscher Aktienindex) in Germany;
CAC 40 (Compagnie des Agent de Change 40 Index) in France;
Nikkei 225 in Japan;
SMI (Swiss Market Index) in Switzerland;
RTSI (RTS Index) in Russia.

The value of a stock index is in direct dependence on the prices of the shares included in the calculation base of the index. Therefore, for example, an upward change in the value of the DJIA index indicates the strengthening of the US economy. The opposite is also true, where a fall in the DJIA index indicates a decline in the U.S. economy.

Changes in stock indices are also reflected in the Forex currency market. Since at Forex one currency is sold and bought for another currency, in order to study the influence of stock indices on a single quote it is necessary to study the dynamics of changes in two stock indices. For example, in the case of USD/CHF quote, we need to study the dynamics of change of DJIA and SMI stock indices. If on the stock market DJIA is steadily growing, and SMI is steadily decreasing, then with a certain degree of error we can say that this trend will inevitably be reflected on the Forex market, and the U.S. dollar rate will grow against the Swiss franc. If both stock indices have growth dynamics, then it is necessary to consider how much the growth dynamics of one index outpaces the growth dynamics of the other, and it is no longer necessary to speak unambiguously about the impact on the Forex currency market.

To summarize the chapter, let us say that forecasting is a creative process. You can use stock indicators in your arsenal of means of forecasting changes in Forex exchange rates, and you can neglect them. Obviously, your decision will depend on how you trade forex. Using stock indicators to predict changes in exchange rates makes sense only in the medium and long term. Moreover, the influence of the stock market on the currency market has a certain inertia and does not affect immediately. In some cases, the opposite effect occurs, when changes in exchange rates on the currency market lead to growth or fall of shares. Therefore, it is important to learn to understand which influence is primary, and this is not always a trivial task. Ultimately, whether or not to apply the knowledge gained in this chapter is your choice. But it is necessary to realize that all economic processes in the world are interconnected!