Intermarket analysis works on the basic principle that all financial markets are linked in some way. This principle applies to domestic as well as to international markets. In conclusion, a complete analysis of one market cannot be accomplished without understanding what is happening in other markets as well.
Some of the most obvious examples for the close relationships of financial markets are stock indexes. While markets are trading in Europe, any movement by the German stock index DAX will influence the French stock index CAC40 and vice versa. All European markets have this kind of relationship.
Some time after the European markets, the American markets will open. What happened in Europe earlier will also affect what is going to happen in America. Also, all American markets are influencing each other. When the Asian markets open, they will be influenced by what happened in Europe and America, and influence each other. The next day, European markets will be influenced by what happened in America and Asia, and the cycle will start again.
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Without understanding what happened and is happening at the other markets, you cannot make a valid prediction for any market. If you pay attention to other markets, on the other hand, you can sometimes see exactly what is going to happen in the market you want to trade.
For example, let us assume that you have recognized an uptrend in the Dow Jones on a daily basis. Currently, this uptrend is going through a retracement. As the retracement is approaching the trend line, you are looking for a sign that prices will turn around to follow the trend’s main direction again. In this scenario, European and Asian market movements can give you a good indication which way the Dow Jones will go today. If Asian markets closed with big profits and European markets opened well too, you know there is a good chance that this is the day the Dow Jones will follow their lead and turn around.
The example of stock indexes is easy to understand: If one index rises the other will rise too. This is called a positive relationship: The direction of one market determines the direction of the other market. Stock indexes, however, are far from the only example for related markets. There is also a positive relationship between industrial metals and stock prices: Rising prices for industrial metals are generated by high demand, which implies a strong economy. A strong economy will eventually benefit stock prices.
There is, however, also the possibility of an inverse relationship. In this case, if one market is going up, the other will go down. For example, commodities and the US Dollar have an inverse relationship. If the US Dollar goes up, commodities usually go down. Since commodities are priced in US Dollar, a rising US Dollar can lead to less demand for commodities, which will lead to falling prices.
Another example for an inverse relationship between is stock prices and interest rates. If the US Federal Reserve, for example, is lowering interest rates, this will put more money into the market. Companies are therefore likely to increase profits, which will influence their stock price.
With most relationships, one market is a little ahead of the other. You can use that time delay to draw conclusions from the first market and apply them to the second market. There are two ways to do that:
Of course, making predictions solely based on intermarket analysis is risky. For most traders it is advisable to combine intermarket analysis with other elements, such as trend analysis in the example above, candlestick patterns, or technical indicators.