Intermarket analysis was popularized by renowned financial market technical analysis expert John J. Intermarket analysis simultaneously takes into account developments in and cross market correlations among the four primary financial markets. Specifically, these markets are: Among other things, intermarket analysis can be used to determine the current progress of the business cycle and how it is likely to affect various market sectors.
Intermarket analysis techniques can therefore provide a useful long term forecasting method for investment market analysts and business managers. The following sections of this article will describe the key intermarket analysis principles and methods and explain how forex traders can use intermarket analysis to make better currency trading decisions and to devise profitable intermarket trading strategies.
Why Use Intermarket Forecasting Techniques? Market price and exchange rate movements may seem to be highly erratic and even random as traders absorb new information, develop new opinions and adjust market prices accordingly. Nevertheless, despite the appearance of a random walk in market prices , analysts have regularly observed that market behavior forms patterns. Furthermore, they note that these same patterns tend to repeat themselves and hence may contain some prized predictive value for the astute observer in terms of the future direction of market pricing.
Given the international nature of financial markets and the ability of traders to quickly absorb and react to new information, related markets now increasingly react together as their participants respond to the same geopolitical and economic information that now quickly reaches all parts of the globe. These global market interrelationships mean that forex traders need to keep themselves aware of what is going on in other related markets, rather than just single mindedly focusing on performing technical analysis on a single currency pair.
Using intermarket analysis helps give currency traders a new edge in this increasingly global and interrelated financial marketplace in which the forex market plays a key and pivotal role, along with bond traders, commodity futures players and stock market operators. Some forex traders ignore such key relationships between markets for the sake of simplicity, however, those that choose to bypass these key interdependencies, do so at their own detriment. The Key Inter Market Relationships.
The four primary markets used in intermarket analysis — i. These well-established intermarket relationships allow those analysts familiar with them to make predictions about future market behavior based upon observations made in a correlated market. In this sense, correlation refers to the degree to which two markets tend to have a relationship with one other that can be described as linear. A positive correlation implies that the correlated markets tend to move in the same direction, while a negative or inverse correlation signifies that the related markets typically move in the opposite direction.
Murphy points out in his aforementioned book on Intermarket Analysis, market analysts have observed a number of key correlated relationships between the stock, bond, currency and commodity markets over the years. Seven of these important intermarket relationships can be described as follows: These commonly observed correlations have a fundamental basis in the relationship between inflation, interest rates and the evaluation process the relevant marketplace goes through to determine suitable prices for goods and companies and exchange rates for currencies.
Not only does intermarket analysis among the stock, forex, bond and commodity markets have a sound fundamental basis , but such relationships can also be analyzed by various methods that seem to fall more into the realm of technical analysis. Tools for Intermarket Analysis. As with many areas of market analysis, one of the primary tools for intermarket analysis is a chart of prices and exchange rates as they have changed over time. For example, intermarket analysts will often superimpose performance charts of the four key markets on top of one another to observe trends and deviations from expected relationships that might present trading opportunities.
Performance charts allow an analyst to compare how different markets performed over a particular time frame. This type of intermarket technical analysis, allows the analyst to evaluate the performance of an asset as the percent change of its closing price observed over time. Each of the colored lines on a performance chart depicts the percent change seen for a particular asset from the starting point on the left side of the chart.
Analysts can use such charts to make comparisons between several assets by superimposing the graphs of several performance lines on a single chart. Figure 1 below shows an example of how such an intermarket analysis performance chart might look.
An intermarket comparison chart plotting the performance of four markets superimposed on a single graph. The lines represent the four markets as follows: This form of graphical intermarket analysis allows the analyst or trader to see how the intermarket relationships evolve over time and whether any performance behavior might indicate that a potentially profitable trading opportunity is present.
It also allows them to evaluate the seven aforementioned intermarket relationships or others they might have identified. Currency Trading and Intermarket Analysis. Many forex traders first come across the concept of intermarket analysis when they observe correlations between the value of the currencies they are trading and key strategic commodities like gold and oil.
Some of the most important currency and commodity relationships are listed below along with explanations regarding why these relationships tend to hold: Gold Related Currency Relationships: Oil Related Currency Relationships: Currency and Equity Market Relationships. In addition to the aforementioned commodity price correlations, some currency pairs also respond to shifts in relevant stock markets.
Another perhaps more complex currency and equity market relationship has to do with the perception of risk and the relative amount of risk aversion among investors in the market. When investors are less risk averse and hence are willing to take risks, the stock market tends to rise.
On the other hand, when investors are seeking safe havens because they are becoming more risk averse, the stock market tends to fall. Developing an Inter Market Trading System. Once traders start to be become aware of intermarket analysis, most of them will want to know how to start trading with intermarket analysis. They also typically want to know how to apply intermarket analysis in forex trading and how to develop a profitable intermarket trading system based on this valuable information.
The numerous details involved in developing and testing an intermarket trading system are beyond the scope of this article. Nevertheless, as a starting point, the interested forex trader can learn how to create and use performance charts like the graph shown in Figure 1 above, which is a key intermarket analysis tool.
This will enable them to research new intermarket correlations and ensure that traditional ones are still relevant. Forex traders should also be aware the typical relationships between relative currency evaluations and commodity or stock market movements detailed above.
Thus, when they see a sharp movement on one side of a correlated pair of markets due to some unexpected news event , they can reasonably expect a corresponding rise or fall in the other side of the pair, depending on whether the established correlation is positive or negative.
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