Introduction to Intermarket Analysis in Forex Trading

For many intermediate and advanced traders, intermarket analysis has become an indispensable approach for assessing the state and dynamics of the markets. By examining the interactions between the major asset classes – equities, bonds, commodities and currencies – intermarket analysis provides traders with a big-picture perspective on global capital flows and emerging trends. As such, this multi-dimensional view can offer valuable signals on potential opportunities, risks and shifts in global trends and the forex landscape.

In this guide, we will explore the key facets of intermarket analysis, its significance in forex trading, and how traders may begin to apply this approach of looking at the interconnectedness of the global financial landscape, in order to single out trading opportunities.

The Four Pillars of Global Financial Markets

To begin to grasp intermarket analysis, we must first understand the four pillars of the financial system and their unique characteristics.

The Equity Markets

As most are aware, the equity markets encompass stock exchanges worldwide where shares of public companies are issued and traded. Fluctuations in stock prices reflect investor sentiment and expectations on the profitability of companies.

From a currency-market perspective, rising stock markets signal positive economic outlook and attract foreign capital inflows, potentially leading to appreciation of the local currency. Conversely, falling markets may indicate poor economic prospects and can spur capital outflows, weakening the local currency.

The Bond Markets

The bond markets allow governments and corporations to raise debt financing by issuing bonds. Investors purchase these bonds and receive periodic coupon payments plus the principal upon maturity.

Bond yields are a key indicator of prevailing interest rates. Rising yields imply higher borrowing costs, increasing a currency’s interest rate differential and appeal to foreign investors. Falling yields signify lower rates, making a currency less attractive.

The Commodities Markets

The commodities markets facilitate the trading of raw materials and primary goods like precious metals, energy, agriculture produce and livestock.

Commodity prices influence currencies, especially of commodity-exporting nations. For example, higher oil prices drive up demand for petrodollars, boosting the values of currencies like the Russian Ruble.

The Foreign Exchange (Forex) Market

The forex market is the world’s largest financial market where international currencies are traded 24/7, in the case of institutions. It influences all other markets as exchange rates impact the value of cross-border investments and transactions.

Why Intermarket Analysis Matters in Forex Trading

Intermarket analysis examines the correlations between the above markets to discern macro-economic trends and cycles. This interdisciplinary approach enhances forex trading in three key ways:

Broad Market Perspective

By tracking developments across markets, intermarket analysis provides a big picture overview on the drivers of currency movements. This prevents traders from operating in silos and missing critical data correlations.

Early Signal Identification

The interplay between markets offers leading indicators on potential opportunities and risks. Identifying these early signals allows traders to get ahead of emerging trends in the forex market.

Risk Management

Correlations between markets help traders gauge portfolio risks posed by global economic scenarios. This aids in balancing risks across asset classes and insulating investments from market volatility.

In summary, intermarket analysis broadens a trader’s market perspective, thereby potentially enhancing their forecasting ability, and risk allocation/management – all critical facets of long-term trading success.

The Pivotal Role of the Bond Market

Of the various asset classes, the bond market wields special influence over currency values due to its role as the benchmark for global interest rates.

Using the U.S. as an example, when the Federal Reserve raises interest rates, yields on U.S. Treasuries follow suit. This makes Treasuries more attractive for foreign investors, who must convert their local currencies into U.S. dollars to invest in Treasuries. The resultant dollar demand appreciates the greenback against other currencies.

Conversely, if the Fed cuts rates and Treasury yields decline, the dollar becomes less appealing to foreign investors who may cash out of dollar-denominated assets. The dollar selling pressure leads to depreciation against rival currencies.

Thus, tracking Treasury yields provides guidance on future shifts in the U.S. dollar and other major currencies like the Euro and British Pound, whose central banks mirror Fed policies.

Interplay Between Equity Markets and Forex

Equity market performance has significant implications for currency markets. As a rule of thumb, surging stock markets support currency appreciation while falling equities lead to currency depreciation.

For example, a thriving U.S. stock market points towards robust economic growth. This outlook attracts foreign capital into U.S. equities, driving up demand for the dollar and causing it to appreciate against peers.

The opposite holds true as well. Lacklustre U.S. stocks diminish the economic outlook and deter foreign investments, reducing dollar demand and weakening it against rival currencies.

Thus, monitoring equity index trends like the S&P 500 offers insights into potential movements of associated currencies. Stock market volatility further influences forex markets, driving traders towards safe haven assets.

Impact of Commodities on Currency Values

Commodity prices, especially crude oil, impact currencies of commodity-dependent nations:

• Rising oil prices lead to higher revenues for oil producers. This raises demand for their local currencies as oil contracts are denominated accordingly. The Russian Ruble, for instance, appreciates when crude prices are buoyant.
• Major gold importing countries like India see robust domestic demand during strong bullion markets. This drives up imports and demand for foreign currency to pay gold suppliers. The Indian Rupee, as a result, depreciates against currencies like the U.S. dollar.
• For agricultural exporters, bumper crop prices boost export revenues and demand for their local currencies. The Australian and New Zealand dollars often strengthen when farm commodity prices are elevated.

Commodity markets should therefore be monitored to determine potential currency impacts, especially in commodity-linked economies.

Safe Haven Currencies and Intermarket Analysis

In times of market uncertainty, investors flock to safe haven assets – currencies that maintain or gain value during volatile conditions. Common safe havens include:

• Swiss Franc (CHF) – Perceived as a stable currency due to Switzerland’s political neutrality and robust fundamentals.
• Japanese Yen (JPY) – Japan is the world’s largest creditor nation with vast foreign assets that are repatriated during crises, lifting the Yen.
• U.S. Dollar (USD) – Liquid U.S. Treasury bonds are sought after during sell-offs, increasing dollar demand.

When turmoil strikes, capital shifts rapidly into these safe havens, causing their values to spike dramatically versus other currencies.

Intermarket analysis should track global economic and geopolitical risks. Heightened risks prompt investors to pre-emptively flock to safe haven currencies, impacting associated currency pairs.

Studying Intermarket Correlations

Examining correlations – the relationships between currency pairs and financial markets – is crucial for implementing intermarket analysis. These correlations can be categorised as:

Positive Correlation

When two assets move in tandem they exhibit positive correlation. For instance, the S&P 500 and the U.S. dollar (USD) generally hold a positive correlation. As explained earlier, a rising S&P 500 attracts capital inflows into U.S. equities, lifting USD demand and causing appreciation against other currencies.

Negative Correlation

Conversely, assets with negative correlation move opposite to one another. Gold prices and the U.S. dollar hold a negative correlation. Rising gold signals inflation concerns, weighing on the dollar. A stronger dollar makes gold more expensive for global buyers, dampening demand and gold prices.

No Correlation

Assets with no correlation display negligible interdependence. For example, USD/JPY exchange rate movements do not directly impact copper futures prices.

Traders can use a matrix tracking the correlations between major currency pairs and financial markets. This empowers traders to more clearly consider positions based on intermarket developments.

Utilising Intermarket Analysis in Trading

Intermarket analysis has diverse applications in currency trading:

Strategy Development

Identifying areas with the highest correlations allows traders to incorporate intermarket dynamics in their strategies. This enhances the analytical rigour and timing of trading decisions.

Risk Management

Monitoring correlations enables traders to avoid overexposure and hedge correlated risks across asset classes. This balances the risk profile of the overall portfolio.

Scenario Planning

Analysing market scenarios through an intermarket lens helps traders evaluate the impact of potential global events on currency markets. This scenario planning enhances readiness and resilience.

In practice, traders can deploy tools like correlation matrices, heat maps, overlays of past trends and more to conduct intermarket analysis and extract trading signals. Ongoing observation is key as correlations continually evolve.

Practical Examples of Intermarket Analysis

Let’s examine two case studies that demonstrate intermarket analysis in action:

Case Study 1: 2015 Commodities Slump

The massive commodities rout of 2015, driven by waning Chinese demand, sent prices of crude oil, metals and minerals tumbling. Intermarket analysis helped traders capitalise on currency movements:

• Declining crude prices hurt petrodollar currencies like the Russian Ruble, Norwegian Krone and Canadian Dollar as oil revenues dropped. Shorting these currencies generated profits.
• Gold prices fell in tandem, boosting the U.S. Dollar as investors sold the precious metal to offset losses elsewhere. Long USD trades capitalised on this trend.

Case Study 2: COVID-19 Pandemic Financial Fallout

As the COVID pandemic unfolded in early 2020, intermarket analysis offered trading advantages:

• Spiking market volatility drove investors towards safe havens like JPY and CHF. Traders profited by buying these currencies against risk-sensitive pairs.
• Collapsing oil demand weakened petro currencies like Ruble and Krone. Short positions on these currencies were lucrative.
• Equity sell-offs propelled capital outflows from emerging markets, depreciating currencies like the Mexican Peso and South African Rand. Traders capitalised by shorting these currencies.

These examples demonstrate the value of spotting early intermarket signals and positioning accordingly.

Recent Developments to Watch

While core principles remain unchanged, intermarket analysis must adapt to evolving dynamics like:

• Rise of retail trading – Growth of platforms like Robinhood has seen retail flows disrupt certain historical correlations.
• Cryptocurrency adoption – Mainstream embrace of crypto is creating new non-correlated assets. These may develop future correlations.
• Global decoupling – As economies decouple post-COVID, some historical intermarket relationships are growing more complex.
• Machine learning advances – Algorithms can now spot obscure linkages between markets, identifying profitable opportunities.

Keeping pace with these developments is crucial for leveraging intermarket analysis. While staying on top of global market developments is its own skill, utlilising a few key tools will make a big difference.

At the very least, it’s important to visualise the interactions of global markets, rather than get lost in a world of raw data.

Using Intermarket Analysis on MetaTrader 4/5 and TradingView

While the theory of intermarket analysis is well-established, its practical application is where the value is truly unlocked. Forex trading platforms like MetaTrader 4/5 and TradingView come with in-built tools to facilitate this analysis. Here’s how to apply intermarket analysis using these platforms:

MetaTrader 4/5

On MetaTrader, you can implement intermarket analysis through the use of multiple chart windows, and custom indicators. With custom tools, overlay charts also can be used.

Multiple Chart Windows: Open different chart windows for each of the relevant asset classes such as Forex pairs, equities, commodities, and bonds. This allows you to monitor multiple markets simultaneously and spot potential correlations or divergences.

Custom Indicators: MetaTrader supports a vast range of custom indicators that can assist with intermarket analysis. Indicators like correlation coefficient, relative strength, and spread can highlight relationships between different markets.

Overlay Charts: This is where you overlay two different assets on a single chart, allowing you to visually spot correlations or divergences between them. For example, you might overlay the S&P 500 index with the USD/CHF chart to see their relationship.

While Metatrader doesn’t natively offer overlay charts, third-party or custom tools would allow you to achieve this within Metatrader itself. Alternatively, many dedicated charting/analysis programs offer in-built overlay charts.

TradingView

TradingView also offers robust tools to conduct intermarket analysis, such as overlay charts, multi-chart layouts, correlation matrix, and a vast repository of user-generated scripts.

Multi-chart Layouts: TradingView allows you to monitor multiple markets simultaneously in one window. You can customise the layout according to your needs and keep track of forex pairs, commodities, equities, and bonds at the same time.

Correlation Matrix: The correlation matrix in TradingView provides a numerical value for the correlation between two different assets over a specific period. This can help you identify whether a positive, negative, or no correlation exists.

User-generated Scripts: The public library of TradingView scripts includes a wide range of user-created indicators designed for intermarket analysis. These scripts can help you spot hidden correlations, assess relative strength, and measure intermarket divergence.

In both MetaTrader and TradingView, backtesting and forward-testing are crucial. These allow you to gauge the effectiveness of your intermarket analysis strategy on historical data before implementing it in live trading.

While the tools provided by these platforms are powerful, they can only provide insights based on historical data and current market conditions. Remember that correlations change over time due to a range of factors, so continuous monitoring and adjustment of your intermarket analysis strategy is necessary.

As the global financial landscape evolves, adapting your intermarket analysis approach to changing market dynamics and incorporating cutting-edge tools and strategies will be integral to navigating Forex markets effectively.

In Summary

Intermarket analysis provides traders with a strategic advantage by examining macroeconomic linkages between global markets. While adopting this approach has its challenges, the benefits are multi-fold. Intermarket analysis offers a forward-looking perspective, aids risk management, and helps spot divergences that unlock trading opportunities early. As financial markets grow more interconnected, harnessing intermarket analysis becomes integral for trading success.