Intermarket Analysis: The Benefits of Tracking Market Correlations

Financial markets are highly connected, and traders should be aware of the various intermarket correlations. Intermarket analysis is the process of looking at various financial markets that have a strong correlation. Correlations can be either positive or negative – ranging from -1.0 (perfect negative correlation) to +1.0 (perfect positive correlation). Thesecould give traders hints about the broad market sentiment, or they could use it to trade on short-term divergences.

In this article, we will have a look some of the major intermarket relationships.

Oil, Canadian Dollar and Norwegian Krone

Both Canada and Norway are major Oil exporters, and movements in the Oil price can have a significant effect on the currencies of those two countries. Generally, rising Oil prices will support the Canadian Dollar and Norwegian Krone, while a decline in WTI/Brent will put the CAD and NOK under pressure.

USOIL - CAD - NOK
USOIL - CAD - NOK

Nikkei and Japanese Yen 

Demand for the Japanese Yen tends to increase amid times of uncertainty and lower risk appetite. The Nikkei – the major Japanese stock index – and the Japanese Yen therefore have a moderate negative correlation. Should sentiment in the equity markets turn sour, a trader might expect the USD/JPY to decline (i.e. the Japanese Yen to rise) along with the Nikkei.

NIKKEI JPY
NIKKEI JPY

Gold and Swiss Franc 

Both Gold and the Swiss Franc have the status of a safe haven, and they tend to move in a similar direction. Thus, a rally in XAU/USD is generally accompanied by a decline in USD/CHF.

GOLD - USD/CHF
GOLD - USD/CHF

There are many more examples, and it is easy to track the correlations by using free online tools that offer a correlation matrix. Chart comparisons are also a way of visualizing those relationships. 

So, how can traders use these insights and incorporate it into their trading?

Along with using it as a gauge for broad market sentiment, some traders use intermarket analysis to identify divergences and trade on them. For example: Oil and the Canadian Dollar are both in a strong downtrend, but a certain event – for example, a Canadian data release – triggers a CAD recovery, while Oil prices remain depressed. Traders expecting the two to move in the same direction might therefore look at a short CAD position to trade on this divergence.

However, it is important to note that correlations can weaken over time. Traders should monitor the correlations frequently, and view them over a long-term period. Furthermore, correlations should be used in addition to other tools, and not as signals on their own.

The information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.