Stocks, bonds, commodities, and currencies are all examples of assets that can be analyzed using Intermarket analysis. The purpose of the analysis is to assess the strength or weakness of the asset class in question. A financial market analyst, John Murphy, initially presented the notion in his book “Trading using Intermarket Analysis.”
According to Murphy, traders can profit from looking at correlations across different asset classes. Investors can use Intermarket research to determine the stage of the investing cycle and the best- and worst-performing asset classes.
Intermarket Analysis: A Step-by-Step Guide
The term “Intermarket analysis” refers to studying asset classes or financial markets with high correlations. For example, an investor can look at associated markets such as the US dollar, commodities prices, and the bond market when studying the US stock market. Commodity prices frequently directly impact the stock market in the United States. As a result, combining commodity and stock analysis can aid in speculating the stock market and its future path.
Correlation of Intermarket Analysis
You can usually analyze the Intermarket correlations between two or more variables using available data, chart comparisons, or a spreadsheet. Investors and traders commonly use correlations to examine the Intermarket link between one variable and a second variable in a separate data set. The strength of the relationship is determined by the degree of correlation between the variables.
1. There is a positive association
A positive or negative correlation might be found in a study of two variables. When two variables have a positive correlation, they move in lockstep. The correlation value can reach +1.0, indicating a perfect positive correlation. This means that two assets or asset classes move in lockstep in the investment sector. Perfect connection is, of course, quite rare.
Any reading between +0.7 and +1.0 that lasts for a long time shows that the two variables are statistically significant to one another. Investors can benefit greatly from intermarket analysis meaning in identifying such correlations when making buy/sell decisions.
2. Correlation that is negative or inverse
A negative correlation, also known as inverse correlation, shows that two variables have a negative relationship. I think this answers the question, can stock prices go negative?
When the relationship is near zero, there is a weak association between the two variables. If the relationship between the two variables shifts from positive to negative (or vice versa), the relationship is unstable and cannot be depended upon to offer trading direction. In essence, there is no consistent relationship between the variables.
Relationships between Inflation and Deflation
Inflationary and deflationary pressures are two major influences on Intermarket analysis and linkages. Bonds and commodities, stocks and bonds, commodities and the US dollar are the most characterized Intermarket connections affected by inflation/deflation.
1. Relationships between inflation and deflation
In an inflationary climate, equities and bonds usually have a positive association. When the value of one asset grows, the value of the other asset rises as well. Bond prices typically reverse direction before stock prices; thus, a reversal in bond prices could shortly signal a shift in stock prices.
Furthermore, during periods of inflation, the US dollar and commodities and bonds, and commodities usually have an inverse relationship. When the price of one asset class rises, the price of the other asset class falls.
2. Relationships that are deflationary
Stock and bond prices frequently have an inverse connection in a deflationary climate. This results in a positive relationship between stock prices and interest rates.
In addition, the US dollar and commodity prices and bonds and commodities have an inverse relationship. These eventualities are the same as they were in an inflationary climate. The only positive correlation is between stock and commodity prices in a deflationary economy.
Intermarket Analysis’ Importance
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Intermarket analysis can offer insight into the trajectory of financial markets in the future. For example, determining the connections between different asset classes might reveal vital confirmations about the asset’s likely trajectory. Relationships between stocks, for example, can reveal whether a new trend is about to emerge. This can assist investors in exiting existing holdings or buying new ones primed to profit from a trend change.
However, no asset analysis approach is intended to be the only way of asset analysis. Intermarket analysis is most effective when used with other analytical tools or approaches; Intermarket analysis is most effective. Also, remember that Intermarket correlations are not guaranteed to remain steady.
Changing economic situations may cause relationships to shift. For example, positive correlations across asset classes may turn negative, or a correlation may vanish entirely, implying that the assets no longer have any statistically significant association.
