Sunday, November 2, 2008

Intermarket Analysis

What is intermarket analysis and why will it work for us in our trading? To see this clearly, we have to understand two things.

  1. The purpose of analyzing markets is to forecast market direction—more simply,to identify trends.
  2. The traditional market approach in forecasting trends is single-market analysis, which is divided into two analytic viewpoints—fundamental and technical.
Fundamental analysis forecasts market direction based on economic factors affecting a market. Technical analysis bases its forecasts of market direction on the idea that all of the internal and external factors affecting a market, at a given point in time, are factored into that market’s price.

The problem with the single-market analytic approach is that it is archaic. Single-market analysis, the predominant approach to analyzing U.S. markets for more than 100 years, works on the assumption that markets trade independently of one another. Although this was true for financial markets, it is no longer the case.

The rise of the Internet (instantaneous information transmission), computerized trading (trading simultaneous markets immediately), software market analysis (the ability to analyze multiple markets immediately), and, most important, the interconnectedness of global markets (the threaded influence of market upon market in all parts of the world) all make single-market analysis alone a less effective tool for forecasting trends. Particularly, single-market technical analysis is less effective because it relies on lagging indicators that view a market retrospectively to identify re-occurring patterns that then form trends. To be clear, single-market analysis is not wrong, nor is it irrelevant for identifying trends; alone, it is simply insufficient.

Intermarket analysis empowers traders to make more effective trading decisions based upon the linkages between related financial markets. By incorporating intermarket analysis into your trading strategies, rather than limiting your scope to each individual market, these relationships and interconnections between markets will work for you rather than against you.

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