April 15, 2024

Building Advanced Horizons

Navigating the World of Business Trading

What It Is and How It Works

4 min read

What Is Intermarket Analysis?

Intermarket analysis is a method of analyzing markets by examining the correlations between different asset classes. It is based on the idea that what happens in one market can affect other markets, so a study of the relationship(s) could prove to be beneficial to traders. One of the most widely known relationships that investors use is the one between stock prices and interest rates on bonds.

Intermarket analysis is usually performed with a correlation study.

Key Takeaways

  • Intermarket analysis is a method of analyzing markets by examining the correlations between different asset classes.
  • A simple correlation study is the easiest type of intermarket analysis to perform, where results range from -1.0 (perfect negative correlation) to +1.0 (perfect positive correlation).
  • A well-known correlation is the inverse correlation between stock prices and interest rates, which postulates that as interest rates go up, stock prices go lower, and vice versa.

Understanding Intermarket Analysis

Instead of looking at financial markets or asset classes on an individual basis, intermarket analysis looks at several strongly correlated markets or asset classes. These can include stocks, bonds, currencies, and commodities. This type of analysis expands on looking at markets or assets in isolation by also looking at others that have a strong relationship to the market or asset being considered.

For example, when studying the U.S. market, it is worthwhile to look at the U.S. bond market, commodity prices, and the U.S. Dollar. For example, changes in related markets, such as commodity prices, can also impact prices in the U.S. stock market either positively or negatively. Understanding these relationships can help traders predict the movement of stock prices with greater accuracy.

Intermarket analysis isn’t just useful to professional traders. Understanding these relationships can also help everyday investors create a more balanced, diversified portfolio.

Intermarket analysis should be considered fundamental analysis in that it relies more on relationships to provide a general sense of direction, but, it is often classified as a branch of technical analysis. There are different approaches to intermarket analysis, including mechanical and rule-based.

Intermarket Analysis Correlations

Performing an analysis of intermarket relationships requires market data and a spreadsheet or charting program. A simple correlation study is the easiest type of intermarket analysis to perform. This type of analysis is when one variable is compared with a second variable in a separate data set.

A positive correlation can go as high as +1.0, which represents a perfect correlation between the two data sets. A perfect inverse (negative) correlation depicts a value as low as -1.0. Readings near the zero line would indicate that there is no discernible correlation between the two samples.

A perfect correlation between any two markets over a long period of time is rare. Any reading sustained over the +0.7 or under the –0.7 level (which would equate to approximately a 70% correlation) is statistically significant.

If a correlation moves from positive to negative, the relationship is most likely unstable and not useful for trading.

The most widely accepted correlation is the inverse correlation between stock prices and interest rates, which postulates that as interest rates go up, stock prices go lower, and conversely, as interest rates go down, stock prices go up.

Do Stocks and Bonds Always Have a Negative Correlation?

Stocks and bonds don’t always have a negative correlation. How they are correlated depends on the broader economic environment. Usually, when inflation is low and the economy is stable, prices for stocks and bonds move in opposite directions (negative correlation). However, when inflation is high, stocks and bonds have a positive correlation, and both their prices move downward.

What Is the Correlation Between Commodities and Currency?

Certain currencies are correlated with commodity prices, usually in countries whose economies are highly dependent on those commodities (either as an exporter or an importer). Usually, the price of a commodity is positively correlated with the currency of an exporter country and negatively correlated with the currency of an importer country. Currency traders can keep an eye on commodity prices to get ahead of these trend reversals.

Why Is Intermarket Analysis Important?

Intermarket analysis is a tool that can help traders and investors spot potential changes in asset prices and try to get ahead of the market. This type of analysis doesn’t give reliable sell signals. Instead, it can confirm that an uptrend or downtrend is likely to continue, or it can signal a potential reversal.

The Bottom Line

Intermarket analysis is a method of analyzing markets for investments. Traders examine the correlations between different types of assets to learn what changes in one asset class might indicate about future changes in another.

The easiest and most common type of intermarket analysis is a correlation study between two variables. This gives a result ranging from -1.0 (indicating a perfect negative correlation) to +1.0 (indicating a perfect positive correlation). A correlation of 70% or greater (at or above +0.7 for a positive correlation or at or below -0.7 for a negative correlation) is statistically significant. If the correlation swings from positive to negative, however, it is likely unstable and unusable, even if it moves above +0.7 or below -0.7.

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