Hey trader,
As many of you know, I’ve been trading for 26 years and teaching for most of that time.
Countless times, on days that saw huge moves in the U.S. dollar, I’d get the question: “How do I sell (or buy) the dollar?”
To help the questioner think it through, I’d respond, “What do you want to own?”
There are two concepts here that tie into one idea.
Money in the markets is like matter. It is neither created nor destroyed, only changing state.
There is no such thing as a standalone transaction.
You can’t buy something without selling something else. You can’t sell something without buying something.
You will always be long one instrument and short another.
These two thoughts tie into one idea: everything is a pairs trade, expressed as Base/Quote.
If you are buying, or long, the base, you are selling, or short, the quote. The reverse holds just as well.
You don’t even buy your morning Starbucks without going long the coffee and short $6.
Let’s make this clearer.
Picture buying NVDA at some point over the last few years with a dollar-denominated account. You would give up your dollars to buy the shares.
Put some numbers behind it. If NVDA trades at $200 per share, you spend $200 for each share, or $20,000 for 100 shares.
NVDA always comes quoted in dollars. Think of it as the NVDA/USD pair.
This works with options too.
Say you sell a put on NVDA. You aren’t directly trading the stock.
You are selling a put contract and collecting premium, which means you are buying U.S. dollars.
You are short the NVDA PUT/USD pair.
Friday’s price action illustrates this concept well.
Equities sold off. Crude, gold, and bonds sold off too.
Now think about the pair. Everything I just listed was the base of the trade.
If all of those were sold, something was being bought.
On Friday, that something was the U.S. dollar. Everything was being liquidated as cash piled up.
This was a classic flight to cash.
Historically, when the U.S. dollar moves aggressively in either direction, U.S. equities tend to move roughly 2.5 times the dollar’s move the opposite way.
On Friday, the dollar gained roughly 0.80%. That implies equities should have lost around 2%.
That is almost exactly what we saw in the S&P 500 futures.
When you hear the word rotation, it really means selling out of one position and buying into another.
We’ve seen rotation away from small caps and into tech.
That’s long Nasdaq, short Russell. Written as a pairs trade, it’s QQQ/IWM or NQ/RTY.
In practice it may not run as a direct pairs trade. The mechanics stay the same.
You sell IWM, collect USD, then sell USD and buy QQQ.
There may be a brief stop through the dollar. The net result is still a pairs trade.
When you see big moves in the market, remember it’s always a pairs trade.
When tech stocks rip and the Nasdaq hits all-time highs, that money came from somewhere.
Something was sold to let the Nasdaq be bought.
When the market sells off hard, something is being bought. That something is usually bonds, defensive stocks, or the U.S. dollar.
Don’t be afraid of the big moves.
Stay aware that when something is gaining, something else is always losing.
Blake Young
Senior Market Strategist, TheoTRADE
