Intermarket Analysis and Economic Theory

One of the things that has really helped me throughout my career as a technician is the ability to look at all markets. Long time readers know that I don't limit my analysis and participation to just US stocks. We're looking at stock markets from all over the world - Australia, Ireland etc. I'm watching commodities like Gold and Silver but also the softs like Corn and Sugar. Currencies play a huge role in our analysis as well. I'm looking at all of the major crosses on a regular basis, not just for trading opportunities, but looking for correlations that may hint at a move coming in another asset.

Getting a top/down macro perspective across asset classes really gives us a huge advantage. More importantly, we are simply expanding our universe of opportunities to make money. If I'm not sure in which direction the Dow Jones Industrial Average might be headed, I don't stress it. There is always something out there where I have more conviction. Perhaps a currency cross or Treasury bonds might present a better risk vs reward. Without analyzing all of these asset classes, one would have no idea what might be happening outside of the US Stock market.

John Murphy, one of the best intermarket analysts out there, had this to say on the subject:

"Intermarket Analysis is based on economic principles. However, it is not theory. Intermarket work is market-driven. There is nothing theoretical about a profit and loss statement. Economists look at statistics to determine the direction of the economy and, by inference, the direction of the financial markets. Chartists look at the market themselves. This is a big difference. While economic statistics are usually backward-looking, the markets are forward-looking. It is much like comparing the relative merits of using a lagging or a leading indicator. Given the choice, most people would choose the leading indicator. This goes to the heart of technical analysis. One of the basic premises of the technical approach is that the price action in each market (and each stock) is also a leading indicator of its own fundamentals. In that sense, chart analysis is just a shortcut form of economic and fundamental analysis. This is also why the intermarket analyst uses charts.

Another reason that chartists have such a big advantage in intermarket work is that they look at so many different markets. Charts make a daunting task much simpler. In addition, it is not necessary to be an expert in any of the markets. All one needs to do is determine if the line on the chart is going up or down. Intermarket work goes a step further by determining if two related markets are moving in the same direction or in the opposite direction. It does not matter if the charts being compared are those of gold, bond yields, the dollar, the Dow, or the Japanese stock market. You do not have to be a charting expert to do intermarket work, either. The ability to tell up from down is all that is needed. And an open mind."

Murphy simplifies it a bit much there at the end, but I think you get the idea. In my intermarket work, I try to add momentum and smoothing mechanisms to the price behavior. We do a lot of correlation analysis in this area as well. I remember back in 2008 during the financial collapse, the euro/yen cross was beautifully correlated with S&Ps and financials. That really helped us a lot during that period of time.

This information is there for us to use. How we use it is all up to our specific risk parameters and objectives. You can keep it as simple as Murphy and just worry about the direction or take it a few steps further to fit your needs. Useful either way.

Source:

Intermarket Analysis: Profiting From Global Market Relationships (Murphy)