Monday, December 17, 2012

Murphy, Trading with Intermarket Analysis

Way back when, John J. Murphy was the voice of technical analysis. With his pioneering 1991 book, Intermarket Technical Analysis, he added a new dimension to his earlier work. Fast forward. We have new trading products available (ETFs, not merely futures), a new economic environment, and relatively inexpensive color printing. Hence Trading with Intermarket Analysis: A Visual Approach to Beating the Financial Markets Using Exchange-Traded Funds (Wiley, 2013).

The book is awash with color: color charts, of course; color heads for “John’s Tips”; color definitions; color “Did You Know?” tidbits. The text’s typeface is elegant but designed for those with perfect vision; it’s about a point size too small for easy reading. Admittedly, with so many charts it would have been tough to keep text and charts in sync if the type size were larger.

Taking a quasi-historical approach to the subject, Murphy divides the book into four parts: the old normal, the 2000 and 2007 tops, the business cycle and ETFs, and the new normal. At every turn he illustrates intermarket relationships with comparative StockCharts, many with their correlation coefficient indicator added.

The basic relationships are: (1) the dollar and commodities trend in opposite directions, (2) bond prices and commodities trend in opposite directions, (3) since 1998 bond and stock prices have trended inversely, and (4) since 2008 stocks and commodities have been more closely correlated. How do they interact? “Bonds usually change direction before stocks. Stocks usually change direction before commodities. Bond yields peak first, stocks second, and commodities last. Those rotations are more reliable at tops than at bottoms.” Globally, stocks are closely correlated and “emerging markets are closely tied to commodity trends.” (p. 216)

Naturally, as Murphy points out, the markets are not static; relationships ebb and flow. For instance, even though stocks usually change direction before commodities, in 2011 commodities led stocks lower. (p. 153) Or consider the performance of gold bullion versus the gold miners stocks. “During the 10 years starting in 2002, gold and gold miners gained 484 percent and 429 percent, respectively, versus a 12 percent gain for the S&P 500 during the same decade. As is usually the case, gold miners did better than bullion in the first few years of that decade. … The relationship changed, however, in a big way during 2008. A plunge in the miners/bullion ratio occurred during that year, when mining stocks fell nearly 30 percent while bullion held relatively flat. The ratio shows that miners have generally matched the performance of bullion since then. They did a little better than the commodity during 2009, but underperformed during 2011.” (pp. 156-57) Murphy offers some possible explanations for the 2008 move and draws some lessons from the miners/bullion ratio over this period, among them: “An uptrend in gold is stronger if gold miners are moving in the same direction.” (p. 158)

Trying to use intermarket relationships to drive profitable trading is a very tricky undertaking, but Murphy’s book is an excellent place to start.

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