Trend Forecasting with Intermarket Analysis

Predicting Global Markets with Technical Analysis

Louis B. Mendelsohn

• Publisher: Wiley
• Year: 2012
• Print ISBN: 9781592803323
• eBook ISBN: 9781118538654
• Edition: 2
• Topic: Business
• Subtopic: Finance
• Index: Business

In this groundbreaking new edition, Mendelsohn gives you the weapon to conquer the limitations of traditional technical trading-intermarket analysis.

To compete in today's rapidly changing economy, you need a method that can identify reoccurring patterns within individual financial markets and between related global markets. You need tools that lead, not lag.

Step by step, Mendelsohn shows how combining technical, fundamental, and intermarket analysis into one powerful framework can give you an early edge to accurately forecasting trends.

Inside, you'll discover:

• Precise trading strategies that can be used by both day traders and position traders.
• The limitations of traditional technical analysis methods-and how to overcome them.
• How neural network computational modeling can create leading, not lagging, moving averages for more accurate forecasting.
• Innovative, quantitative trend forecasting indicators at the cutting edge of market analysis.

PLUS-an introduction to VantagePoint Software, which makes Mendelsohn's "new economy" trading methods work simply-and effectively. This software applies the pattern recognition capabilities of advanced neural networks to analyze intermarket data on literally hundreds of global financial markets each day.

CHAPTER 1

TRADING IN A GLOBAL ECONOMY

Change is one of the constants of life. If you’re a long-time trader, it’s been coming at you with increasing speed in the last few decades, totally altering the landscape of the traditional open-outcry auction market that characterized trading since the middle of the 19th century.

The 1970s introduced financial futures contracts on currencies and interest rates for the first time, as well as a new energy market and the ability for U.S. investors to own gold again after a more than 40-year hiatus. Throw in a steep stock market setback and inflationary conditions that propelled prices of commodities, such as soybeans and sugar, to astronomical levels, and investors began to flock to the commodity trading arena in a big way.

The 1980s produced a number of new trading concepts and instruments—cash-settled futures contracts, options on futures, and futures and options based on stock indexes. As inflation cooled, the markets shifted from contracts based primarily on physicals to new offerings based on paper. The advent of personal computers opened up participation in these markets to a new generation of individual traders and, as personal computers advanced, software designed to analyze and trade markets proliferated as more traders turned to technical analysis techniques to help them make their trading decisions.

The 1990s brought the Internet, a quantum leap in global communications that ushered in the global economy and opened up the information world to traders. This set the stage for electronic trading, which culminated in the technology stock “bubble” that took the stock market to unprecedented levels before the “irrational exuberance” of day-traders and others caught up with the market. Right now, personal computers and analytic software continue to undergo significant improvements in speed, performance, and user-friendliness.

The 2000s built on the technological advances of the Internet and personal computers in all areas of business and daily life, perhaps most notably in the trading industry’s shift to electronic trading. Within a short time after contracts became available on electronic platforms, trading volumes set records in currencies, stock indexes, and many other markets as hedge funds, loaded up with bundles of cash needing to be deployed, became dominant market players with which individual traders had to contend and compete. Electronic trading played a big role in changing the face of the financial markets and trading industry as the global economy expanded and various exchanges throughout the world merged with one another or made the transition from membership organizations to publicly owned companies.

ONE CONSTANT REMAINS

Yet, with all the advances in technology and all the resources now available to individual traders, one statistic has remained relatively constant over the years: The overall success rate of individual traders from a profitability standpoint has not improved materially since the days of pit trading. One reason, in my opinion, is that technical analysis has continued to emphasize a market-by-market approach and has not kept pace with structural changes that have occurred in the financial markets related to the emergence of the global economy. Another important reason is that individual traders often lack an adequate understanding of market behavior, dynamics, and the mechanics of trading. As a result, there is an enormous need for education and training, particularly for novice traders who are just getting involved in the global financial markets.

With the speed and extent of data and news now available, mass psychology and market sentiment seem to change daily, if not hourly. Based on the latest tidbit of information—or misinformation—market sentiment abruptly shifts from bullish to bearish and back again. One day a futures market or individual stock is overbought, the next day it is oversold. One day concerns over higher oil prices, due to a threatened hurricane’s effects on oil rigs in the Gulf of Mexico and refineries on the Gulf Coast, or problems in the U.S. mortgage credit markets spreading elsewhere are of paramount importance to traders; the next day these subjects are practically forgotten as traders move on to the next hot button topic.

Just as television viewers hop from one sound bite and one hot topic to the next and switch channels with the touch of a remote control, traders have a difficult time maintaining their focus, discipline, and perspective as they try to make sense of often conflicting information about interest rates, economic growth, inflationary expectations, terrorist threats, hurricane forecasts, employment numbers, and many other day-to-day concerns and influences on the markets. To the novice, these sudden shifts between greed and fear, bullishness and bearishness, optimism and pessimism, hope and resignation, seem to take place with little rhyme or reason.

However, despite what seem like erratic and unexplainable shifts in opinions, patterns of market behavior often repeat themselves over and over again. They can be found within every market at different periods in time and by analyzing various relationships between related markets. The global financial markets now, more often than not, move in concert, driven by common financial, political and economic forces affecting the global economy.

No longer can traders rely solely upon single-market technical analysis methods, which were designed for, and more appropriate to, the relatively independent and less volatile domestic markets of the late 20th century and may have sufficed in a previous period. Intermarket analysis tools that can identify reoccurring patterns within individual financial markets and between related global markets give traders a broadened trading perspective and competitive edge in the 21st century global financial markets.

The increasing interconnectedness between financial markets, even seemingly distantly related, in the global economy and the growing interdependencies among global commodity, futures, debt and equity markets has made intermarket analysis an important and necessary facet of research and market analysis by traders. Because the markets are a financial version of Darwin’s survival of the fittest competition, intermarket analysis tools and methodologies that build and expand upon single-market analysis methods demand serious attention by traders if their involvement in the financial markets is to be profitable and not just a short-lived, costly and painful learning experience.

MARKET EVOLUTION

The emergence of a new era of global electronic communications was heralded by the first transatlantic satellite transmission in 1962 and was greatly expanded by the rapid development of the Internet since the early 1990s. Together with the creation of new currency, interest rate, oil and stock index products in the 1970s and 1980s, the world’s futures and equity markets, previously distinct from one another, have merged into one giant global financial network.

The proliferation of financial futures since the mid-1970s laid the early foundation for the global integration of the financial markets following the decision by the United States to abandon fixed exchange rates in 1971. Those developments have made intermarket analysis a necessary adjunct to the more traditional single-market technical analysis that proliferated following the advent of personal computers in the late 1970s, as volatility in interest and exchange rates, as well as energy prices, created new trading opportunities and risks for speculators and hedgers. This included multinational corporations and the growing number of hedge funds that scour the world’s financial markets for places to put their leveraged capital to work.

In the past, trading was conducted on a local level within separate time zones on individual domestic stock and commodity exchanges. Japanese and other Far East stocks traded primarily in Tokyo or other Asian trading centers. European stocks traded in London and elsewhere in Europe. U.S. stocks traded in New York while domestic and foreign commodities and futures traded primarily in Chicago and New York. With the links between the financial centers of the world established and their influence on each other becoming more evident every day, the melding of the debt, equity, futures, derivative, and options markets throughout the world has continued unabated, most significantly in the global foreign exchange market known widely as the FX or forex market.

As these interrelationships of previously disparate markets have developed and strengthened, exchanges worldwide have been moving at a frenetic pace in the first decade of the 21st century to establish linkages with each other. Hardly a week goes by without some announcement of exchanges merging or acquiring trading partners in other areas of the world, expanding into other market arenas, or launching new electronic trading facilities. In addition, many exchanges have moved from member-owned organizations to for-profit publicly owned corporations in the last few years. It is not an exaggeration to describe these rapid changes among exchanges as a complete revolution in the trading industry, further accelerating the globalization of the financial markets.

BRAVE NEW EXCHANGE WORLD

Even the staid old exchanges of the past like the New York Stock Exchange (NYSE), Chicago Board of Trade (CBOT), and Chicago Mercantile Exchange (CME) have worked out direct ties to, or strategic alliances with, foreign exchanges. In many cases, these new arrangements between exchanges have been sparked by the drive to facilitate expanded electronic trading, which allows traders to trade any financial instrument, anywhere in the world, at any time over seamless, electronic global trading platforms.

Just look at a few of the recent new alignments in the exchange world:

• Traditional rivals like the CME and CBOT decided first to both use one clearing organization, then the CME acquired the CBOT in 2007 after a contentious battle in a merger of futures exchange leaders that surprised traders and has been hailed as the deal of the century in the trading world.
• The New York Mercantile Exchange agreed to trade its products electronically on CME’s Globex platform, starting with energy and then adding metals when it became obvious that its Comex division was losing precious metals trading share to CBOT’s electronically traded contracts. With the CME-CBOT merger, the CBOT metals contracts were dropped. This cooperative effort between two formerly highly competitive cities is quite a turnabout from the heated battles of the past.
• The Intercontinental Exchange (ICE), an upstart electronic energy marketplace based near Atlanta, acquired the New York Board of Trade, the last exchange to rely only on open-outcry pit trading, and changed its name to ICE Futures US in 2007. The acquisition produced an instant boost in volume in cotton, sugar, cocoa, and coffee futures when those contracts started trading electronically, and the exchange dropped pit trading altogether at the end of February 2008. ICE also almost pulled off a coup to acquire the CBOT until CBOT members voted to merge with the more established CME, but ICE came back from that setback by acquiring the Winnipeg Commodity Exchange.
• The NYSE and other stock exchanges have taken various routes to move into commodities and futures markets; and futures exchanges have returned the favor by moving into the realm of equities markets and the fixed-income arena that has long been the domain of the over-the-counter marketplace.
• Many exchange alliances went international in a frenzied rush to form links with partners in other parts of the world. The NYSE’s high-profile merger with the Paris-based Euronext is only one of many recent agreements by exchanges to expand their business to new territories and new markets.
• Sovereign states have even gotten a piece of the trading action as Middle Eastern countries such as Dubai and Qatar, flush with cash from their oil revenues, went on shopping sprees to purchase large stakes in the Nasdaq Stock Market, London Stock Exchange, and Sweden’s OMX Market in complex arrangements that open up a whole new range of issues related to regulation and security. It remains to be seen how U.S. and other international exchanges will be able to compete against such oil-rich countries in their efforts to become bigger players on the world stage. Joining the exchange fray in recent years has been a number of new electronic communication networks (ECNs). They have taken a share of trading from traditional exchange centers, helped in part in the United States by the March 2007 inauguration of the National Marketing System, which mandated that order flow be directed to the exchange offering the best price for customers. Among these is BATS (an acronym for Better Alternative Trading System) Trading Inc. in Kansas City, Mo., far removed from the financial centers of New York and Chicago. Major brokerage firms and banks such as Merrill Lynch, Morgan Stanley, Credit Suisse, and others own stakes in BATS and other ECNs as they move to minimize trading costs and compete more aggressively for customers.
• New exchange alliances and efficiencies of electronic trading open the financial markets to a broader audience for new contracts based on markets that were not even envisioned just a few years ago—contracts based on carbon emissions and other factors related to global environmental issues like hurricanes, snowfall, and temperatures in major cities; housing futures; new twists for credit derivatives; and a number of other areas as exchanges devise innovative new instruments and ways to manage risk and go head-to-head with the competition provided by over-the-counter arrangements.

These are just some of the developments that are changing the face of the trading industry in the first decade of the 21st century—you almost need a scorecard to keep track of the changes every month. Now both sophisticated traders as well as novices realize that they have to take more interest in looking beyond just one market to the convergence of many related markets, not just geographically but also in product areas, as more attention is focused on risk management on a 24-hour global basis.

It is no longer far-fetched to imagine that some day soon there will be one totally comprehensive electronic global trading network combining major equities and commodity exchanges throughout the world without the turf concerns about where a brick-and-mortar exchange is located. Concepts of “after hours trading,” “extended trading,” and “open outcry” will undoubtedly become historical footnotes to our lexicon, just as the “buggy whip” and the “horseless carriage” were relegated at the dawn of the 20th century.

Advances in technology and electronic trading will continue the evolution of how trading is conducted and, of course, will influence how firms and individual traders approach a 24-hour marketplace where literally thousands of financial instruments, including esoteric ones not yet conceived, can be traded. Even small institutional trading organizations will need to staff their trading operations around the clock, and many individual traders may suffer from insomnia; they may feel compelled to check their market positions at all hours of the day or night with the concern and worry that there is the potential for some cataclysmic, overnight worldwide meltdown of the financial markets, precipitated by any number of triggering events in today’s post 9/11 world.

With advances in the Internet and personal computer capabilities, the speedup in the dissemination of information will continue to push many traders into adopting shorter-term trading strategies as the concept of “buy and hold” as a conservative trading strategy falls by the wayside and is replaced by more aggressive, short-term approaches. After all, an uptrend is an uptrend; a trend reversal is a trend reversal. Patterns will repeat themselves, regardless of the timeframe or label that is put on a market, whether it is pork bellies, the S&P 500 Index, the euro, or Intel. The worldwide intermingling of (and blurring of the lines between) equities and futures will continue to accelerate and create new opportunities and challenges for traders.

EMERGING ECONOMIC FORCES

The trading world, of course, does not exist or function in isolation. It is one facet in an ongoing stream of interconnected events that influences and is influenced by other economic, political, and social factors—from new products and concepts to changes in political structures. Here is a brief recap of a few of the more significant technological, economic, financial, and political forces that have converged to bring about the globalization of the world’s financial markets in the first decade of the 21st century:

Advancements in information technologies including computers, satellite, software, and telecommunications. These are focused on the global expansion and commercialization of the Internet and the development of electronic global communications and trading networks. Transactions involving the purchase and sale of financial instruments, tangible property, and the raising of capital will be conducted freely, instantaneously, and competitively on a worldwide level. These developments will render obsolete the concepts of local financial markets and economic nationalism.

• Expansion of global derivatives trading involving interest rate futures, stock indexes, options, and debt-related ETFs. The marriage of derivatives trading with information technologies will continue to meld previously disparate markets, further increasing market interdependencies and bringing about the total internationalization of the financial markets.
• Increased global free trade and competition and the globalization of multinational corporate financing strategies involving capital formation, hedging of foreign exchange and interest rate risk, cross-border listing of shares on multiple exchanges in different countries, corporate consolidations, and cooperative competition through global alliances and mergers and acquisitions (particularly within brokerage, investment banking, and telecommunications, as well as between exchanges) across national boundaries.
• Government deregulation involving the banking, brokerage, energy, telecommunications, and transportation industries. Reductions in marginal tax rates, which stimulate economic activity and global competition; reallocation of capital geographically and from the public to the private sector; increased productivity, lowered costs, and spurred innovation in the development of new technologies.
• Productivity gains brought about by advancements in information technologies positively affecting the cost structure of corporate enterprises and streamlining and shortening supply chains and customer channels.
• Demographic increases in demand for financial assets and broader participation in privatized, tax-deferred profit-sharing and retirement plans by baby boomers.
• Demographic demands resulting from the emergence of a burgeoning middle-class in such countries as China, India, South Korea, and elsewhere for many products and services. As they continue to open up their economic and financial institutions to the broader global economy there will b...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Foreword
• Preface
• Introduction
• Chapter 1: Trading in a Global Economy
• Chapter 2: Technical Analysis for Today’s Markets
• Chapter 3: Chart Patterns: Building Blocks of Technical Analysis
• Chapter 4: Technical Indicators: Enhancing Price Patterns
• Chapter 5: Using Intermarket Analysis to Gain an Edge
• Chapter 6: Mining Intermarket Data With Neural Networks
• Chapter 7: Using Intermarket Data for Predictive Indicators
• Chapter 8: Applying Predictive Indicators to Trading Strategies
• Chapter 9: The Synergistic Trader
• Suggested Reading
• Important Internet Sites
• About the Author and Market Technologies, LLC