Chapter 17. Stock Exchanges and Stock Indices

Despite the fact that the focus of the Forex Arena informational portal is Forex education, in this chapter, we will discuss stock exchanges and stock indices. At first glance, it may seem that the content of this chapter is unrelated to Forex, but in reality, it is not the case. Currency exchange rates in the global foreign exchange market have a correlation with stock indices, which is why studying the latter can be a valuable tool in your arsenal for analysis and forecasting in Forex.

Before we delve into the main stock exchanges, let's explore the participants of the stock market to better understand its organization. In the previous chapter, we learned that the stock market involves trading in securities. Securities are issued by issuers, which are companies and organizations that raise funds to support their business operations. Investors with available funds invest in securities with the aim of generating future profits. Brokers are professional financial intermediaries licensed to facilitate such transactions. They help buyers and sellers of securities find each other to execute mutually beneficial deals. Brokers conduct their activities on behalf of and at the expense of their clients, earning compensation in the form of commissions for their services. Stock exchanges and over-the-counter trading systems are the marketplaces where securities trading takes place, often utilizing electronic trading platforms. A specialized organization called a registrar maintains records of the issuer's securities and their current owners. The portfolio of securities held by individual investors is recorded and managed by a depository. Like any other business sector, the stock market operates under the supervision of regulatory and oversight bodies, and there are also consulting and information firms involved in the industry.

So, securities trading takes place on stock market platforms (exchanges and over-the-counter trading systems). The majority of global stock trading volumes are concentrated on two trading platforms:

• NYSE (New York Stock Exchange) - The New York Stock Exchange.
• NASDAQ-AMEX – The combination of the over-the-counter NASDAQ (National Association of Securities Dealers Automated Quotations) platform and the AMEX (American Stock Exchange) exchange.

In addition to the mentioned platforms, other notable stock exchanges include:

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

We will not delve into the long-term factors that influence stock prices, as discussing this topic in detail would take a significant amount of time. We will also not extensively cover the classification of company stocks based on their industry sectors. However, it's worth mentioning that there are several sectors, each with its own attractiveness to investors. When investing in stocks of a particular industry, it remains a constant fact that higher returns entail greater risk for the investor. The topic of analyzing a company's financial performance for investment decision-making is also beyond the scope of this website. Nevertheless, it's important to know that there is quantitative analysis of financial statement indicators (quarterly, annual) and qualitative analysis of the management policies implemented by the company.

Indeed, there is a correlation between the Forex market and the stock market. As we know, the exchange rate of a currency is directly influenced by the state of its country's economy. The overall state of an economy depends on various factors, with Gross Domestic Product (GDP) being a key indicator. There are multiple methods of calculating GDP, but for the purpose of our discussion, it is important to understand that the better the financial position of companies representing key sectors of a country (reflected in higher stock prices on the stock market), the higher the GDP and the more stable the currency. This means that if the stocks of companies representing key sectors of a country experience price growth, the currency of that country tends to appreciate in value on the Forex market.

Thus, the question remains: how can we quantitatively determine the state of the stock market in a particular country? This is where stock market indices come into play. Each stock market has its own set of indices that reflect the state of its market. Stock market indices are calculated based on the value of selected stocks (in a specific proportion) included in the index calculation. Although there is a wide variety of stock market indices, each trading platform typically highlights the most important ones that closely reflect the state of the stock market and the economy of their respective countries. Let's list some of the main stock market indices:

• DJIA (Dow Jones Industrial Average – the Dow) in the United States;
• NASDAQ Composite (National Association of Securities Dealers Automated Quotations) ) in the United States;
• S&P 500 (Standard and Poor’s 500 Index) ) in the United States;
• FTSE-100 (Financial Times Stock Exchange 100 Index) in the United Kingdom;
• 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 market index is directly dependent on the prices of the stocks included in its calculation. Therefore, for example, an increase in the value of the DJIA index indicates a strengthening of the US economy, while a decrease in the DJIA index reflects an economic downturn in the US.

Changes in stock market indices also have an impact on the Forex market. Since Forex involves the buying and selling of one currency against another, studying the influence of stock market indices on a specific currency pair requires analyzing the dynamics of two stock market indices. For instance, in the case of the USD/CHF currency pair, we need to examine the dynamics of the DJIA and SMI stock market indices. If the DJIA index is consistently rising while the SMI index is steadily declining, with a certain margin of error, we can anticipate that this trend will inevitably affect the Forex market, resulting in an increase in the USD/CHF exchange rate. On the other hand, if both stock market indices show an upward trend, we need to assess the extent to which the growth rate of one index outpaces the growth rate of the other, and it becomes less conclusive to predict the impact on the Forex market.

In conclusion, forecasting is a creative process. You can choose to include stock market indicators in your arsenal of forecasting tools for predicting currency exchange rates in Forex, or you can disregard them. Your decision will depend on your trading approach in Forex. The application of stock market indicators for currency rate forecasting makes sense primarily in the medium and long term. Furthermore, the impact of the stock market on the currency market has a certain inertia and does not happen immediately. In some cases, there is a reverse influence, where currency rate changes lead to an increase or decrease in stock prices. Therefore, it is important to learn to understand which influence is primary, and this is not always a straightforward task. Ultimately, whether to apply the knowledge gained in this chapter or not is your choice. However, it is crucial to understand that all economic processes in the world are interconnected.

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