Intermarket Analysis

Commodity, stock, currency and bond markets are closely interconnected. Understanding their interactions allows traders to develop effective trading strategies. Together with technical buy and sell signals, this information greatly enhances the accuracy of the analysis. When one of the markets begins to show leading signs, you can better customize your analysis.

Fundamentals of intermarket analysis

Often reversals are preceded by divergences. For example, if the dollar strengthens, we can expect commodity prices to decline. If this does not happen immediately, it is a sign of divergence and commodity prices are likely to start falling soon.

Another example: declining bond prices when stocks are rising. While this trend may continue for a while, in an inflationary environment, stocks will eventually follow bonds. To confirm trends, we can assume that existing relationships will continue: if commodity prices rise and bonds fall, this movement will continue. Similarly, the fall in stocks is likely to continue while bonds are falling and for some time after they stabilize.

Global Divergences

By utilizing the correlations between global markets, it is possible to extend the analysis by confirming the conclusions with other markets. It is ideal when global markets confirm what is happening in the local market. For example, if the U.S. stock market is rising and overcoming resistance, the trend is considered strong if other global markets show similar dynamics. Markets with strong correlations, such as those in the Eurozone, Canada or China, should be watched.

In 2008, the synchronized decline in global markets confirmed the strength of the downtrend. Although there may be time lags between the movements of different markets, strong trends should appear synchronized. If the other markets are stable, it is unlikely that U.S. markets will experience a significant decline without confirmation from other global markets.

Assets that reflect cross-market correlations

Having received signals from various markets that a new trend is ready, individual stocks can be used to pinpoint the start of the trend. For example, stocks that are highly correlated with the price of oil and financial sector stocks that are sensitive to interest rates.

These stocks often outperform their respective futures markets, allowing you to predict their movements. The upward movement of commodity stocks confirms the market’s readiness for a bullish trend. For example, in 2008, oil stocks peaked and retreated ahead of oil prices, which foreshadowed their imminent decline.

Financial and service sectors

The bullish performance of interest rate sensitive stocks points to weakening inflation and rising liabilities, suggesting lower interest rates and a possible rise in equities. The strengthening of financial sector stocks at the end of a market cycle is supported by gains in industrial and technology sector stocks. Service sector stocks often move in sync with bonds, confirming trends in the Treasury market.

Conclusion

When global markets confirm movements in the local market, it confirms the continuation of the current trend. Tracking stocks leading asset classes provides early indications of the beginning of a move. Understanding intermarket relationships helps you select the most promising market to open a trading position based on trends. This approach is effective for medium to long term trades, but requires consideration of events that can disrupt intermarket relationships.