A Forex Stick for Stock Market Bulls

From the Desk of Ian Culley @IanCulley

Did you see the candlestick in the Mexican peso last Friday?

It was all wick!

The way I learned it, you want to trade in the opposite direction of blow-offs like this. 

That means betting on a stronger peso and an end to the stock market correction.

Check out the XXXL lower shadow in the Mexican peso futures (denominated in USD):

Last Friday’s intraday swing spanned six percent and registered the highest single-day ATR reading since March 2020.

Despite the earth-shattering volatility, the bulls prevailed. That’s the critical lesson from last week’s action: The bulls immediately repaired the damage. 

That trend will likely continue in the coming weeks and months. If it does, US stocks, especially the materials sector, will resume their uptrend.

Check out the historically positive correlation between the Mexican peso and the Materials Sector ETF $XLB:

It could be more of a falling dollar than a rising peso driving the relationship. 

Nevertheless, an upside resolution in the Mexican peso follows the underlying trend and supports a breakout in XLB. It would also signal a return to Easy Street for the broader stock market. 

Here’s an overlay chart of the VIX with the USD/MXN pair:

As the Mexican peso rallies (or the dollar-peso sells off), stock market volatility tends to contract. 

This has a lot to do with the carry associated with holding a short dollar-peso position. It’s an easy way to make a buck in a low-volatility environment.

But investors ditch this carry trade when uncertainty hits the market and implied volatility rises.

Perhaps I’m overthinking it. 

These positive correlations could easily break down.

Either way, I’ll continue to track the Mexican peso for insight and bank on a stock market rally until the data proves otherwise.

Am I silly for valuing the peso's next move?

What do you think?

–Ian

Thanks for reading.

Be sure to download this week’s Currency Report!