Before we begin to study the individual relationships, I'd like to lay down some basic premises or guidelines that I'll be using throughout the book. This should provide a useful framework and, at the same time, help point out the direction we'll be going. Then I'll briefly outline the specific relationships we'll be focusing on. There are an infinite number of relationships that exist between markets, but our discussions will be limited to those that I have found most useful and that I believe carry the most significance. After completion of the overview contained in this chapter, we'll proceed in Chapter 2 to the events of 1987 and begin to approach the material in more specific fashion. These, then, are our basic guidelines:
1. All markets are interrelated markets don't move in isolation.
2. Intermarket work provides important background data.
3. Intermarket work uses external, as opposed to internal, data.
4. Technical analysis is the preferred vehicle.
5. Heavy emphasis is placed on the futures markets.
6. Futures-oriented technical indicators are employed.
These premises form the basis for intermarket analysis, which as statistics shows has become on of the most needed branches asked for online via the free job search. If it can be shown that all markets—financial and nonfinancial, domestic and global—are interrelated, and that all are just part of a greater whole, then it becomes clear that focusing one's attention on only one market without consideration of what is happening in the others leaves one in danger of missing vital directional clues. Market analysis, when limited to any one market, often leaves the analyst in doubt. Technical analysis can tell an important story about a common stock or a futures contract. More often than not, however, technical readings are uncertain. It is at those times that a study of a related market may provide critical information as to market direction. When in doubt, look to related markets for clues. Demonstrating that these intermarket relationships exist, and how they can be incorporated into our technical work, is the major task of this book.
INTERMARKET ANALYSIS AS BACKGROUND INFORMATION
The key word here is "background." Intermarket work provides background information, not primary information. Traditional technical analysis still has to be applied to the markets on an individual basis, with primary emphasis placed on the market being traded. Once that's done, however, the next step is to take intermarket relationships into consideration to see if the individual conclusions make sense from an intermarket perspective.
Suppose intermarket work suggests that two markets usually trend in opposite directions, such as Treasury bonds and the Commodity Research Bureau Index. Suppose further that a separate analysis of the top markets provides a bullish outlook for both at the same time. Since those two conclusions, arrived at by separate analysis, contradict their usual inverse relationship, the analyst might want to go back and reexamine the individual conclusions.
There will be times when the usual intermarket relationships aren't visible or, for a variety of reasons, appear to be temporarily out of line. What is the trader to do when traditional technical analysis clashes with intermarket analysis? At such times, traditional analysis still takes precedence but with increased caution. The trader who gets bullish readings in two markets that usually don't trend in the same direction knows one of the markets is probably giving false readings, but isn't sure which one. The prudent course at such times is to fall back on one's separate technical work, but to do so very cautiously until the intermarket work becomes clearer.
Another way to look at it is that intermarket analysis warns traders when they can afford to be more aggressive and when they should be more cautious. They may remain faithful to the more traditional technical work, but intermarket relationships may. serve to warn them not to trust completely what the individual charts are showing. There may be other times when intermarket analysis may cause a trader to override individual market conclusions. Remember that intermarket analysis is meant to add to the trader's data, not to replace what has gone before. I'll try to resolve this seeming contradiction as we work our way through the various examples in succeeding chapters.
EXTERNAL RATHER THAN INTERNAL DATA
Traditional technical work has tended to focus its attention on an individual market, such as the stock market or the gold market. All the market data needed to analyze an individual market technically—price, volume, open interest—was provided by the market itself. As many as 40 different technical indicators—on balance volume, moving averages, oscillators, trendlines, and so on—were applied to the market along with various analytical techniques, such as Elliott Wave theory and cycles. The goal was to analyze the market separately from everything else.
Intermarket analysis has a totally different focus. It suggests that important directional clues can be found in related markets. Intermarket work has a more outward focus and represents a different emphasis and direction in technical work. One of the great advantages of technical analysis is that it is very transferable. A technician doesn't have to be an expert in a given market to be able to analyze it technically. If a market is reasonably liquid, and can be plotted on a chart, a technical analyst can do a pretty adequate job of analyzing it. Since intermarket analysis requires the analyst to look at so many different markets, it should be obvious why the technical analyst is at such an advantage.
Technicians don't have to be experts in the stock market, bond market, currency market, commodity market, or the Japanese stock market to study their trends and their technical condition. They can arrive at technical conclusions and make intermarket comparisons without understanding the fundamentals of each individual market. Fundamental analysts, by comparison, would have to become familiar with all the economic forces that drive each of these markets individually—a formidable' task that is probably impossible. It is mainly for this reason that technical analysis is the preferred vehicle for intermarket work.