In the actual world, no market exists in isolation. Whether it’s FOREX, equities, commodities, or any other financial market, there’s usually some sort of correlation between them. Consider the following simple example of an electronics market. The local economy, savings trends, technology improvements, and interest rates are all likely to have an impact on sales and purchases in this market. Similarly, we cannot expect the global FOREX market to function in isolation without being influenced by a variety of other factors. While it is almost difficult to monitor and account for every single element influencing currency exchange rates, it is possible to evaluate the interdependence of significantly relevant markets.
What is Intermarket Analysis?
Intermarket analysis is a method of assessing markets that involves looking at the relationships between various asset classes. In other words, what happens in one market can and almost always does affect other markets, therefore studying the relationship(s) can be advantageous to the trader.
Intermarket analysis is a method of assessing markets that involves looking at the relationships between various asset classes. A simple correlation study is the simplest type of intermarket research to perform, with findings ranging from -1.0 (perfect negative correlation) to +1.0 (perfect positive correlation). The most widely acknowledged correlation is the negative correlation between stock prices and interest rates, which holds that when interest rates rise, so do stock prices, and vice versa.
Intermarket Analysis Correlations
An investigation of intermarket linkages is relatively straightforward, requiring only data, which is publicly available and free these days, and a spreadsheet or charting tool. The simplest type of intermarket analysis is a simple correlation study. This form of study compares one variable to another variable in a separate data collection. A positive correlation can reach +1.0, indicating a perfect connection between the two data sets. A score of -1.0 indicates a complete inverse (negative) correlation. Readings near the 0 line imply that no visible association exists between the two samples.
A perfect correlation between any two markets over a long period of time is uncommon, but most analysts would undoubtedly agree that any reading sustained above or below +0.7 (equivalent to around a 70% correlation) is statistically significant. Furthermore, if a correlation shifts from positive to negative, the relationship is likely to be fragile and unhelpful for trading. The most widely accepted correlation is the inverse correlation between stock prices and interest rates, which states that when interest rates rise, stock prices fall, and vice versa when interest rates fall.
Forex Intermarket Analysis Pros & Cons
- Diversification: Intermarket analysis allows traders to diversify their trading strategies and reduce risk by taking into account other markets’ trends and behaviors.
- Probable Improved Accuracy: By using intermarket analysis, traders may be able to get a more comprehensive view of the overall market and make predictions based on a wider range of data.
- Enhanced Understanding: Forex intermarket analysis can help traders better understand how different financial markets affect one another, which can lead to more informed trading decisions.
- Complexity: Intermarket analysis can be complicated and time-consuming, especially for new traders who are still learning about the forex market.
- Data Overload: There is a vast amount of data to analyze, making it difficult to sort through and find relevant information.
- Unforeseeable Changes: While intermarket analysis can provide valuable insights, the financial markets can be unpredictable and subject to rapid changes that may not be captured by the analysis.
- Cost: The cost of accessing the necessary data and analysis tools can be a barrier for some traders, especially those just starting.
Intermarket analysis is a useful tool for long-term or medium-term forecasting. While these intermarket connections normally function over longer periods of time, they are prone to draw-downs or periods when they do not work. Large events, such as the 2008 US financial crisis, might disrupt particular relationships for several months. The Industrial Metals/Bond Ratio chart could be one of the broad market indicators used to analyze the stock market’s overall strength or weakness.
Although nothing in trading is perfect, correlations frequently drive exchange rates in an orderly and reasonably predictable manner. Obtaining trading signals from a single source is not a good idea and should be avoided. While using intermarket analysis, the trader ensures that the most essential fundamental driving forces for any given currency pair are taken into account.
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