Inter-market analysis is the study of how different markets (stocks, bonds, commodities, forex, etc.) interact with each other. The idea is that no market operates in a vacuum. Movements in one market often influence or correlate with movements in others. Understanding these relationships can help predict market direction and enhance your trading strategies.
Core Concepts in Intermarket Analysis:
◦ Different markets often have positive or negative correlations. For instance, commodities like gold or oil can influence currencies like XAUUSD (gold) or USDCAD (oil-related). Similarly, stock indices like the S&P 500 often correlate with the USD as risk appetite changes in equity markets can influence forex.
◦ The risk-on/risk-off sentiment drives the flow of capital between various markets. In a risk-on environment, traders tend to favor higher-risk assets like stocks, emerging market currencies, or commodities. In a risk-off environment, traders flock to safer assets such as bonds, gold, and the US dollar.
◦ Markets tend to rotate between asset classes depending on investor sentiment and macroeconomic conditions. Understanding these rotations helps traders identify which markets are gaining strength and which are weakening.
Key Market Relationships in Inter-market Analysis
1. Currencies and Commodities (Forex ↔ Commodities)
◦ Gold and the US Dollar often have an inverse relationship. When the USD strengthens, gold typically weakens, and vice versa. This is because gold is priced in dollars, so a stronger dollar makes gold more expensive for holders of other currencies.
◦ The Canadian Dollar tends to be positively correlated with the price of crude oil since Canada is one of the world's largest oil producers. When oil prices rise, the CAD usually strengthens against the USD.
◦ The Euro can also show a correlation with crude oil, as many European countries import significant amounts of oil. When oil prices rise, it can lead to inflationary pressures, which could weaken the Euro due to concerns about higher energy costs.
2. Bonds and Equities (Bond Market ↔ Stock Market)
◦ There’s an inverse relationship between bond yields (e.g., US 10-year Treasury yield) and stock prices. When bond yields rise, stock prices often fall, and vice versa. This happens because higher yields make bonds more attractive relative to stocks, prompting investors to move money into bonds.