Why should I care about other markets if I only trade ___?

A benefit of having traded different markets and instruments is that I have gained different perspectives on the capital markets. I realize that all markets are ultimately related. Rather it is fundamental, technical, or quantitative analysis, traders are essentially analyzing the supply and demand of the instrument that they are trading. But supply and demand is influenced solely by money flow in the capital markets. As such, it is the dynamics of money flow that drives the movement of something as big as EUR/USD or as small as a penny stock. Secondly, money do not appear out of thin air or do they evaporate. Money moving out of one thing end up somewhere else, and vice versa. Consider a dollar in your wallet. Where does it come from? Where will it go? You probably have a good idea of that yourself. Similarly, money moving in and out of a stock comes from somewhere and go somewhere too. That somewhere can be as close as the next stock in that same exchange. Or, it can be moved to another market (e.g. bonds or commodities) entirely. This happens more often than I used to think because this is how the institutions and the pros play. They don't limit themselves to any particular exchange or any market. They simply go where the money is. As you can see through this simplistic mental exercise,

  1. money flow is the only driver of prices
  2. money has to come from somewhere and go somewhere

That is the reason why I say all markets are related. It is also the reason why even if you trade a local or a specialized market, it is essential that you are at least aware of what's happening around. Not doing so is just willingly ignoring a large part of valuable data. Bill Cara has a saying that "markets do not operate in a vacuum". In his weekly review on March 14, 2010,

Global equity markets do not trade in a vacuum. It is important to be watching these markets move through a trend juncture together, pushed and pulled by global currency and commodity strength or weakness as well as local and regional economic forces.

I like to visualize the capital markets (stocks, commodities, forex, etc.) as an interconnected web. Granted, some points are connected more than others. But push or pull on any point and you can see the effect throughout the web. One practical use of this concept in trading is that if one market is moving up or down, you can observe its impact on the global financial web to estimate (using historical patterns or some blackbox model) will that move pick up momentum or will it retrace back to where it was. This is the essence of intermarket analysis.

Posted 17 March 2010 in trading.