In the last articles we presented the following tips for successful trading:
- Understand market technology as what it is
- Flexible view of the markets
- Individual properties of markets
- Find Edge
In a nutshell, the first point is to understand market technology as a tool and not as a reliable means of forecasting. The second point was that markets change their behavior. Therefore, you should not intervene in a functioning system, but should become suspicious in the event of irregularities in performance and make adjustments if necessary.
With tip no. 3, traders should know the individual characteristics of the markets they trade well. They are one step further to reach tip no.4, namely to find an edge compared to other trading systems. The edge is the advantage that a trader can define for himself. The means for this can be different - either systematically through market technology or just through fundamental knowledge.
Tip No. 5 - Knowing market relationships
Our tip No. 5 is now about the To further develop knowledge. Seen in this way, the Edge could be the last tip because it combines all the tips. The knowledge that traders should have internalized is the interrelationships between the most important markets.
These interrelationships are also summarized under the so-called intermarket analysis. Markets interact with each other because capital flows through asset class to asset class shifts. The individual markets correlate with each other either positively or negatively. Which asset classes are meant:
This refers to the tradable ones assets. Of course, property prices and other capital market products are also important, but mostly not of great relevance for traders, unless they mainly focus on fundamental analysis.
What are the interrelationships between the above-mentioned asset classes? You can either read that or find out yourself using a benchmark analysis. Let's compare stocks and bonds of the most important market (USA).
The upper chart shows that share and bond prices correlated negatively from mid-2012. However, this is not a correlation that - as is often wrongly assumed - always exists. It depends on how high the risk is perceived in the two markets. In the longer term, the two markets can also correlate positively with one another. Bond prices often have a lead.
The second chart shows the oil price (green) and the US dollar index (black). The US dollar index represents the value of the US dollar against the six most liquid currencies, such as the euro and the British pound. In most cases, the two values (currency and commodity) correlate negatively with one another. It is striking that the oil price does not follow the US dollar, but the other way around; the US dollar follows the oil price. The expression Petrodollar is definitely justified in this context.
The following chart shows the comparison between the S&P 500 index (black) and the copper price (green). Copper is considered an economic indicator and accordingly also an indicator of the development of the stock markets. It is striking that the copper price also offers a good indication in the medium term.
Conclusion - intermarket analysis is important
The intermarket analysis does not necessarily have to be part of the trading system, but it helps to understand the markets as a unit. In this unit, demand rotates depending on how market participants' expectations align. The interrelationships and preliminaries in some markets can also represent a certain forecasting ability. For example, bonds and stocks correlate negatively in a normal environment, while they can also correlate positively in markets supported by monetary policy.
Commodities are often dependent on demand and thus expectations of the economy. Copper, in particular, is a good leading indicator for both the economy and the stock markets. The US dollar, on the other hand, seems to be more dependent on the oil price than the other way around.
All in all, the field of intermarket analysis is very broad and requires a lot of effort. However, it can help you get an edge over others because not all exploit these relationships - at least to different degrees.
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