As a new or experienced trader within the forex market, it is of vital importance that you understand the relationship of the forex market to other markets. This includes global financial markets in terms of forex, and also commodities and stock markets. This relationship is easy to overlook, but in fact, these intricate relationships are key to success in the entire ecosystem. For this reason, it is vital to be knowledgeable of, and conduct a regular and thorough intermarket analysis as a forex trader.
What is an Intermarket Analysis?
An intermarket analysis quite literally is the study of the relationship and correlation between two different markets. The four major markets subjected to this type of technical analysis are stocks, bonds, commodities, and currencies. When engaged in forex trading, these relationships are of course highly significant, as no market can exist in isolation.
An intermarket analysis, when conducted correctly, regardless of what form of the market you are engaged in from stock trading to forex, can generally assist in identifying general market trends and noting with a string degree of accuracy, when a reversal in the market is occurring.
This is crucial information for traders to be aware of beyond the typical forex analysis conducted without consideration of intermarket factors. Such accuracy when conducting an intermarket analysis is made possible due to the generally accepted levels of correlation between these major markets. These relationships are complicated, but do provide the key to unlocking the intermarket analysis and deciding whether a market is suitable for trading.
The Complex Relationship of Connected Markets
There are a vast number of factors which impact the relationships of these markets. First, it is important to note the different relationships which can occur. A perfectly positive correlation is defined as +1.0. This effectively means as the price of one market rises, the price of the other market will also rise. The opposite of this relationship is an inverse correlation, which, when perfectly inverse reaches a point of -1.0. The clearest example of an inverse relationship exists between currencies and commodities. Typically, when a currency is strong, commodities are weak.
These relationships are very rarely perfectly positive or inverse. Looking at a very basic example between commodities and currency to illustrate this relationship, let’s take Gold vs USD and how this has a knock-on impact on traders in the forex market.
Commodities Up / Currencies Down
In times of economic instability, investors tend to sell their currency in favor of gold. This is because gold is viewed as much more secure and possessing intrinsic value which does not diminish. The US Dollar being the major currency in the world, typically sustains negative impact in this case.
How that impacts relations in the forex market is, Australia, as the world’s largest producer of gold benefits from the increased demand, strengthening the AUD and leading to an increase in the AUD price against the USD in the forex market.
Japanese Yen vs Nikkei
Another excellent example of how an intermarket correlation can impact the forex trading market is found when we examine the inverse correlation between the JPY and the Nikkei. As the stock market moves downwards, the JPY gains strength. This is generally considered to occur due to people’s view of the Yen as a safe-haven. This ultimately changes the forex trading relationship between the Japanese Yen and U.S. Dollar as it gains strength. On the opposite side, as the Nikkei strengthens, the JPY generally weakens as to does its strength in the USD/JPY market.
These are representative of very simple examples as to how one market can have a significant impact on the others, and ultimately the individuals in the stock and forex trading markets. For this reason, it is key that if you engage in forex online trading, you not only have knowledge of how to conduct a basic intermarket analysis, but that you also have at least some understanding of the correlations between the markets and how they can impact your forex trades.
Key Reasons to Conduct an Intermarket Analysis
As we have demonstrated, the connections between the forex and other financial markets are interwoven and can have a marked impact on each other when changes occur. This is why it is important not just to seek out the best forex deals you can find, but also to make some considerations of the wider market.
Most of the major forex trading platforms will feature extensive analytical tools which will allow you to conduct in-depth technical analysis to get a solid picture of the intermarket state when considering a trade move. The vital point in this respect though is that you know how to interpret the information you are viewing. For this reason, the importance of dealing with an online forex broker who provides top quality educational material, such as that of tradefw, cannot be overstated.
To conclude, we can now appreciate the deep connection between the forex market and the other financial markets. These can be very easily influenced and cause an impact on the entire sector. This is the impact which we must strive to understand when we engage in both online trading of currencies, commodities, stocks, and bonds. With the connection of some very basic relationships and a knowledge of how they impact each other in the general markets, we can go a long way to greatly enhancing our opportunities within the forex trading market.