The opening bell on November 29, 2017 produced an interesting trade pattern within the U.S. Cash Indices. The E-mini NASDAQ (NQ) futures contract turned lower with a significant amount of momentum while other typically correlated indices, such as the E-mini S&P (ES) and E-mini Dow (YM) recorded new all-time intraday highs.
While it is not a common occurrence, clear divergences within markets that are generally strongly correlated make it worthwhile to follow all correlated markets to uncover potential trade opportunities.
The below chart features both the ES and NQ 5-minute charts at the opening bell. The large green candlesticks in the ES (top chart panel) indicate big prices moves just after the open. One can easily determine the ES kicked off the trading day in a generally positive sentiment with only slight pauses in the overall higher trend. Conversely, the NQ took a nosedive right as the market opened.
When divergences in correlated markets occur, there are two general camps of thought.
- Either the ES is leading the NQ, or vice versa, and there is potential trading opportunity in the lagging market. Hypothetically speaking, if you feel the NQ market has overreacted or oversold, and the underlying trend upward is still in place, then there could be an opportunity to long the NQ hoping it would recover from the selloff to realign with its traditional spread to the ES. The same can be said for shorting the ES if you believe the ES is the lagging market. Its very possible that the NQ is “ahead” on the news and the ES is mispriced.
- Because the ES and NQ are generally correlated, is it safe to say the spread that occurred at the open will eventually close? Traders in this camp could potentially long the ES and short the NQ simultaneously with the hopes that both markets will revert to their previous correlated nature.
Regardless of your approach when trading divergences in typically correlated markets, there is no guarantee that each market will realign, and past performance is not indicative of future results. Both potential approaches have their risks and employing proper risk mitigation efforts such as protective stops is paramount.
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