How to Use Intermarket Signals for High-Probability Trading Decisions

John Murphy's intermarket analysis provides a effective toolkit for traders to make high-probability trading decisions. By understanding the relationships between the four major asset classes, traders can identify confirming and diverging signals that can help them to enter and exit trades with greater confidence.

Confirming Signals: When the Markets Are in Agreement

Confirming signals occur when the different asset classes are behaving in a way that is consistent with a particular economic outlook. For example, in a healthy bull market, you would expect to see stocks rising, bond prices falling (yields rising), commodity prices rising, and the US dollar falling. When all of these signals are in alignment, it provides a strong confirmation of the bullish trend.

Trading Application: A trader who sees a breakout in the S&P 500 could look for confirmation from the other asset classes. If bond prices are falling, commodity prices are rising, and the dollar is falling, it would give the trader greater confidence to go long stocks.

Diverging Signals: When the Markets Are in Disagreement

Diverging signals occur when the different asset classes are behaving in a way that is inconsistent with each other. For example, if the stock market is making new highs, but the bond market is also rallying (yields falling), it would be a bearish divergence. This is because a rally in bonds suggests that the “smart money” is concerned about the economic outlook, even though the stock market is still bullish.

Trading Application: A trader who sees a bearish divergence between stocks and bonds might consider taking profits on long stock positions or even initiating a short position. These divergences can often be early warning signs of a market top.

The Role of Technical Indicators

While intermarket analysis provides the big-picture context, traders still need to use technical indicators to time their entries and exits. Murphy is a strong advocate of using basic technical analysis tools, such as trendlines, moving averages, and momentum oscillators, in conjunction with intermarket analysis.

Entry Rules: A trader might use a bullish intermarket signal as a reason to look for a long entry. They could then use a technical indicator, such as a moving average crossover or a breakout above a resistance level, to time their entry.

Exit Rules: A trader might use a bearish intermarket signal as a reason to exit a long position. They could then use a technical indicator, such as a break of a trendline or a move below a support level, to time their exit.

Risk Management and Money Management

No matter how strong the intermarket signal, it is essential to practice sound risk management and money management. This includes setting a stop-loss order on every trade, risking only a small percentage of your capital on any single trade, and having a clear plan for taking profits.

By combining the power of intermarket analysis with traditional technical analysis and sound risk management, traders can significantly improve their odds of success in the market.