Intermarket Analysis

Intermarket analysis is a form of technical analysis that examines diverse financial markets by discerning the relationships between various asset classes. It enables investors to establish how the performance of one market can impact another and to what extent. Based on this information, they can make trading decisions.

In intermarket analysis, investors consider multiple assets such as stocks, bonds, commodities, and currencies to receive a complete picture. The intermarket correlation can range anywhere from -1 to +1. -1 signals a strong negative correlation, +1 indicates a strong positive correlation, and 0 shows no identifiable correlation.

• Intermarket analysis is a research technique experienced investors and investment services companies adopt to understand the market relationship through the correlation between markets.
• This technique assumes that the performance of one market can affect another on a scale from -1 to +1.
• When the degree and direction of correlation are understood, traders can use the relationship to make investment decisions, such as when to enter or exit a market.
• Financial analyst John Murphy popularized the idea in his 2004 book - Intermarket Analysis: Profiting from Global Market Relationships.

Intermarket analysis, introduced by American financial analyst John Murphy, delves into the connection between various markets through the correlation of specific securities. John Murphy Intermarket analysis approach assesses how one market's conditions can affect another, focusing on stocks, bonds, commodities, and currencies.

For instance, the 2008 financial crisis that began in the United States affected countries worldwide. In the United Kingdom, it caused a recession. In India, it led to decreased investor confidence and reduced gross domestic product (GDP). Forex intermarket analysis became prominent for investors trading in currencies and commodities.

Another such example is the negative correlation between gold and USD. When the price of gold increases, USD decreases and vice versa. This is because investors would rather invest in gold than the USD when the market declines.

That said, it is essential to move on to the technical side of the concept. Different assets are analyzed, and a correlation is established. Let us understand the positive and negative correlation with some examples.

1. Positive correlation

This signifies a direct link between markets or asset classes. Events in one market influence another. For instance, consider bond yields and currency values. High bond yields attract investments, bolstering a country's currency.

Correlation Range for Positive Correlation:

• Perfectly positive correlation: +1
• Sufficient positive correlation: +0.7 to +1
• Positive correlation: 0 to +0.7

2. Negative correlation

Here, an inverse connection exists between markets and assets. When one market falters, the other thrives, and vice versa. A prime example is the relationship between gold and the USD.

Correlation Range for Negative Correlation:

• Negative correlation: 0 to -0.7
• Sufficient negative correlation: -0.7 to -1
• Perfectly negative correlation: -1

While achieving a perfect correlation is uncommon, anything exceeding 70% suffices to identify a meaningful relationship. Conversely, a correlation of zero signifies an absence of a discernible link between the two markets.

Consider the following examples to understand the concept.

Example #1

Let us consider an example of a forex intermarket analysis. Suppose Jason wanted to invest in USD. However, his fund manager advised against it, as the price of gold was increasing. Therefore, Jason chose to invest in EUR, which had an almost-perfect negative correlation with USD and was not as expensive as gold as of then.

Example #2

Imagine a scenario where geopolitical tensions are rising, leading to uncertainty in global markets. In this situation, an intermarket analyst observes the following relationships:

• Gold and currency pairs: As geopolitical tensions escalate, investors flock to gold, a traditional safe-haven asset. This surge in demand causes the price of gold to rise. Simultaneously, currencies like the Swiss Franc (CHF) and Japanese Yen (JPY) strengthen as investors seek refuge in these currencies. It establishes a negative correlation between the USD/CHF and USD/JPY currency pairs, both of which decline.
• Oil and stock markets: Geopolitical tensions can disrupt the global oil supply, leading to a spike in oil prices. This increase negatively impacts stock markets worldwide. As oil prices rise, major stock indices like the S&P 500 experience declines, reinforcing the negative correlation between oil prices and stock market performance.
• US Treasuries and emerging market currencies: During periods of geopolitical uncertainty, investors often seek safety in US Treasury bonds. This increased demand causes US bond prices to rise. Consequently, the US dollar (USD) strengthens against emerging market currencies like the Turkish Lira (TRY). It establishes a positive correlation between US bond prices and the USD/TRY currency pair, with the USD gaining strength.

By recognizing these intermarket relationships, investors can make more informed decisions.

Trading with intermarket analysis is complicated. Firstly, identifying a direct or inverse relationship is more accessible, but determining the intensity of impact is extremely difficult. However, once that is done, the investor can use that information to get a clear picture of when to enter or exit a market.

It also helps traders identify new trends and, especially, reversals. One example of this is the stock-bond correlation. Stocks and bonds have a positive correlation. However, bonds change direction faster. Therefore, if bonds signal a reversal, stocks can also anticipate a reversal.

Extreme market situations, such as the 2008 financial crisis and the COVID-19 pandemic, had pushed global economies down. Traders searched for resilient and stable markets and assets. Identifying intermarket relationships early on facilitates investors to reduce losses or at least break even.

Nevertheless, investors should only partially rely on this technique. It is only an accessory that will provide better results when used with other fundamental and technical analysis methods.

An intermarket analysis cheat sheet specifies the relationships between prominent currencies, commodities, and asset classes whose relationship has been pre-determined and established.

While these relationships are commonly observed, it is essential to remember that a wide range of factors influences financial markets, and correlations can change over time.

This article has been a guide to what is Intermarket Analysis. Here, we explain it along with its examples, cheat sheet, and importance. You may also find some useful articles here -

• Advanced Technical Analysis
• Mcclellan Oscillator
• Rising Wedge Pattern