Traders resort to doing intermarket analysis all the time, as part of their effort to confirm whether or not a market which has a given pattern or signal in place, is really about to make a move. Many times patterns and signals seen on the market charts can be misleading, have poor timing, or be completely false. Intermarket analysis is simply a way to check if other correlated markets also have similar patterns and signals on their charts, or any kind of clue that would suggest that these signals are dependable.
Intermarket analysis is difficult because markets tend to work in complicated ways, and only one sector or stock index may be most relevant to the entire market at any given time. This is why usually a single stock market sector or index leads the rest of the market for some time, then things change and another sector or index becomes the leader. Traders look for that single stock market sector, or stock index which is most relevant to the market at that period in time, and use that specific market, to compare its technical status against the market they are trading. This kind of intermarket analysis, on a technical level, is far more precise and more dependable than just analysing a whole bunch of different correlated markets. This is because analysis can be too extensive and therefore can become overwhelmingly confusing, as these markets will never have too much in common. They are correlated, but they always have completely different technical signals on their charts, so nobody knows which ones are correct and which not. That’s why it is better to focus the entire intermarket analysis on one or two correlated markets that are most relevant to the entire market for that period in time.
Analysing too many markets leads to confusion, and even more uncertainty than the one before. Intermarket analysis is about looking at relevant markets, not many markets. In fact stock market sectors and indices tend to lead for a while, then they become less relevant as another sector or index leads, and they simply go through periods of adjusting, where the signals given have no importance. That is why by simply looking at the charts of too many markets does not help in predicting those markets. Simply put, even a single sector or index which is most relevant to the market, can be right, and it can prove all other sectors and indices wrong. Traders choose to trade one market all the time, such as the SP500 or the Nasdaq, for reasons of popularity, better margins and so on, but their intermarket analysis is done on a single sector or index at a time, the one they believe is most relevant. How relevant a stock sector or index is, depends on the phase of the economic cycle. Most traders look at semiconductor stocks, or real estate stocks, or a group of high tech stocks, depending which is most relevant at that time.
The above chart shows the popular SP500 stock index (Above), as well as the semiconductor sector and Russel 2000 stock index (below). The SP500 falls, briefly breaching its 200 day moving average, and the semiconductor sector also falls, seemingly confirming the potential reversal to the downside. But semiconductor stocks and even high tech stocks are not the most relevant at this time in the market, because they have already rallied and led the rally for way too much and too long. And now, it is other, non high tech stocks that are leading, the Russel 2000 index is an index which at this time is leading the market, having taken the lead from the Nasdaq, and it also shows a positive divergence against the SP500, while trading well above its own 200 day moving average. This hinted that the sell signal on the SP500 would likely be a false one, and indeed it turned out to be false.
Intermarket analysis can be used successfully by traders who perform technical analysis on the charts but also understand fundamental analysis, in order to determine which stock sector or index is most relevant to the market now, and do their technical intermarket analysis on that sector or index. Otherwise, traders are forced to perform a massive intermarket analysis on all possible correlated markets, and because there are simply way too many such markets, this leads to an overwhelming amount of technical intermarket analysis to be carried out, too many conflicting signals out of correlated, less relevant markets, being in adjusting phase, and the end result is more confusion and no useful results.
The conclusion is that there is no unique or perfect approach to the markets, and one cannot go very far with technical analysis alone, one still needs to have the understanding of the economic cycle and which markets are most relevant to each phase of that cycle. This is fundamental analysis and even that is not straightforward to learn. The one thing to note here is that the minority of few stocks or even a single index can win over the vast majority of many more stocks and indices, simply because the entire market will eventually go in the direction that the minority, of the most relevant stocks or index had indicated.
