How can you use intermarket analysis to improve your returns?

1 Identify the dominant market

The first step is to identify which market is the most influential and dominant in the current economic environment. For example, if the bond market is showing signs of rising interest rates, this may have a negative impact on the stock market, as higher borrowing costs reduce corporate profits and consumer spending. Alternatively, if the commodity market is experiencing a boom, this may boost the stock market, as higher demand and prices reflect economic growth and inflation. You can use various tools and indicators, such as yield curves, inflation rates, and economic cycles, to determine the dominant market and its direction.

2 Analyze the intermarket relationships

Analyzing the dominant market's effect on other markets is the next step. For instance, if the bond market is dominant and interest rates are rising, stocks and bonds may move inversely as higher interest rates reduce the present value of future cash flows and the opportunity cost of holding stocks. Similarly, commodities and bonds may move inversely as higher interest rates decrease demand for commodities and increase the value of the dollar, which is the main currency for commodity trading. On the contrary, currencies and bonds may move in the same direction as higher interest rates attract capital inflows and increase demand for the currency of the country with higher rates. To measure and visualize this intermarket relationship's strength, various charts and indicators can be used such as relative strength, correlation coefficients, and cross-market analysis.

3 Apply the intermarket analysis to your trading and investing strategy

The final step is to apply the intermarket analysis to your trading and investing strategy and adjust your portfolio allocation and risk management accordingly. For example, if the bond market is dominant and interest rates are rising, you may reduce your exposure to stocks or shift to sectors that are less sensitive to interest rates, such as technology, health care, or consumer staples. Additionally, you could increase your exposure to commodities or sectors that benefit from higher commodity prices, such as energy, materials, or agriculture. You may also want to increase your exposure to currencies that have higher interest rates or stronger economic fundamentals, such as the US dollar, the Canadian dollar, or the Australian dollar. Various tools and techniques can be used in order to apply the intermarket analysis to your trading and investing strategy and improve your returns; these include asset allocation models, diversification strategies, and hedging methods.

4 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?