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INTERMARKET

TECHNICAL

ANALYSIS

TRADING STRATEGIES

FOR THE GLOBAL

STOCK, BOND, COMMODITY

AND CURRENCY MARKETS

John J. Murphy

Wiley Finance Editions

JOHN WILEY & SONS, INC.

New York • Chichester • Brisbane • Toronto • Singapore

In recognition of the importance of preserving what has

been written, it is a policy of John Wiley & Sons, Inc. to

have books of enduring value printed on acid-free paper,

and we exert our best efforts to that end.

Published by John Wiley & Sons, Inc.

Contents

Reproduction or translation of any part of this work

beyond that permitted by Section 107 or 108 of the

1976 United States Copyright Act without the permission

of the copyright owner is unlawful. Requests for

permission or further information should be addressed to

the Permissions Department, John Wiley & Sons, Inc.

Preface

This publication is designed to provide accurate and

authoritative information in regard to the subject

matter covered. It is sold with the understanding that

the publisher is not engaged in rendering legal, accounting,

or other professional service. If legal advice or other

expert assistance is required, the services of a competent

professional person should be sought. From a Declaration

of Principles jointly adopted by a Committee of the

American Bar Association and a Committee of Publishers.

1 A New Dimension in Technical Analysis

2 The 1987 Crash Revisited—an Intermarket Perspective

3 Commodity Prices and Bonds

4 Bonds Versus Stocks

5 Commodities and the U.S. Dollar

6 The Dollar Versus Interest Rates and Stocks

Library of Congress Cataloging-in-Publication Data

Murphy, John J.

Intermarket technical analysis: trading strategies

for the global stock, bond, commodity, and currency markets /

John J. Murphy.

p. cm. — (Wiley finance editions)

Includes index.

ISBN 0-471-52433-6 (cloth)

1. Investment analysis. 2. Portfolio management. I. Title.

II. Series.

HG4529.M86 1991

332.6-dc20

7 Commodity Indexes

8 International Markets

122

9 Stock Market Groups

149

10 The Dow Utilities as a Leading Indicator of Stocks

173

11 Relative-Strength Analysis of Commodities

186

12 Commodities and Asset Allocation

206

13 Intermarket Analysis and the Business Cycle

225

90-48567

14 The Myth of Program Trading

240

15 A New Direction

253

Printed in the United States of America

Appendix

259

20 19 18 17 16 15 14 13

Glossary

273

Index

277

III

To Patty, my friend

and

to Clare and Brian

Preface

Like that of most technical analysts, my analytical work for many years relied on

traditional chart analysis supported by a host of internal technical indicators. About

five years ago, however, my technical work took a different direction. As consulting

editor for the Commodity Research Bureau (CRB), I spent a considerable amount of

time analyzing the Commodity Research Bureau Futures Price Index, which measures

the trend of commodity prices. I had always used the CRB Index in my analysis of

commodity markets in much the same way that equity analysts used the Dow Jones

Industrial Average in their analysis of common stocks. However, I began to notice

some interesting correlations with markets outside the commodity field, most notably

the bond market, that piqued my interest.

The simple observation that commodity prices and bond yields trend in the

same direction provided the initial insight that there was a lot more information to

be got from our price charts, and that insight opened the door to my intermarket

journey. As consultant to the New York Futures Exchange during the launching of

a futures contract on the CRB Futures Price Index, my work began to focus on the

relationship between commodities and stocks, since that exchange also trades a stock

index futures contract. I had access to correlation studies being done between the

various financial sectors: commodities, Treasury bonds, and stocks. The results of

that research confirmed what I was seeing on my charts—namely, that commodities,

bonds, and stocks are closely linked, and that a thorough analysis of one should

include consideration of the other two. At a later date, I incorporated the dollar into

my work because of its direct impact on the commodity markets and its indirect

impact on bonds and stocks.

The turning point for me came in 1987. The dramatic market events of that year

turned what was an interesting theory into cold reality. A collapse in the bond market

during the spring, coinciding with an explosion in the commodity sector, set the stage

PREFACE

for the stock market crash in the fall of that year. The interplay between the dollar, the

commodity markets, bonds, and stocks during 1987 convinced me that intermarket

analysis represented a critically important dimension to technical work that could

no longer be ignored.

• Another by-product of 1987 was my growing awareness of the importance of

international markets as global stock markets rose and fell together that year. I noticed

that activity in the global bond and stock markets often gave advance warnings of

what our markets were up to. Another illustration of global forces at work was given

at the start of 1990, when the collapse in the American bond market during the first

quarter was foreshadowed by declines in the German, British, and Japanese markets.

The collapse in the Japanese stock market during the first quarter of 1990 also gave

advance warning of the coming drop in other global equity markets, including our

own, later that summer.

This book is the result of my continuing research into the world of intermarket

analysis. I hope the charts that are included will clearly demonstrate the interrela-

tionships that exist among the various market sectors, and why it's so important to be

aware of those relationships. I believe the greatest contribution made by intermarket

analysis is that it improves the technical analyst's peripheral trading vision. Trying to

trade the markets without intermarket awareness is like trying to drive a car without

looking out the side and rear windows—in other words, it's very dangerous.

The application of intermarket analysis extends into all markets everywhere on

the globe. By turning the focus of the technical analyst outward instead of inward,

intermarket analysis provides a more rational understanding of technical forces at

work in the marketplace. It provides a more unified view of global market behavior.

Intermarket analysis uses activity in surrounding markets in much the same way

that most of us have employed traditional technical indicators, that is, for directional

clues. Intermarket analysis doesn't replace other technical work, but simply adds

another dimension to it. It also has some bearing on interest rate direction, inflation,

Federal Reserve policy, economic analysis, and the business cycle.

The work presented in this book is a beginning rather than an end. There's still

a lot that remains to be done before we can fully understand how markets relate

to one another. The intermarket principles described herein, while evident in most

situations, are meant to be used as guidelines in market analysis, not as rigid or

mechanical rules. Although the scope of intermarket analysis is broad, forcing us to

stretch our imaginations and expand our vision, the potential benefit is well worth

the extra effort. I'm excited about the prospects for intermarket analysis, and I hope

you'll agree after reading the following pages.

A New Dimension

in Technical Analysis

One of the most striking lessons of the 1980s is that all markets are interrelated—

financial and nonfinancial, domestic and international. The U.S. stock market doesn't

trade in a vacuum; it is heavily influenced by the bond market. Bond prices are very

much affected by the direction of commodity markets, which in turn depend on the

trend of the U.S. dollar. Overseas markets are also impacted by and in turn have

an impact on the U.S. markets. Events of the past decade have made it clear that

markets don't move in isolation. As a result, the concept of technical analysis is

now evolving to take these intermarket relationships into consideration. Intermarket

technical analysis refers to the application of technical analysis to these intermarket

linkages.

The idea behind intermarket analysis seems so obvious that it's a mystery why we

haven't paid more attention to it sooner. It's not unusual these days to open a financial

newspaper to the stock market page only to read about bond prices and the dollar. The

bond page often talks about such things as the price of gold and oil, or sometimes

even the amount of rain in Iowa and its impact on soybean prices. Reference is

frequently made to the Japanese and British markets. The financial markets haven't

really changed, but our perception of them has.

Think back to 1987 when the stock market took its terrible plunge. Remember

how all the other world equity markets plunged as well. Remember how those same

world markets, led by the Japanese stock market, then led the United States out of

those 1987 doldrums to record highs in 1989 (see Figure 1.1).

Turn on your favorite business show any morning and you'll get a recap of the

overnight developments that took place overseas in the U.S. dollar, gold and oil,

treasury bond prices, and the foreign stock markets. The world continued trading

while we slept and, in many cases, already determined how our markets were going

to open that morning.

John J. Murphy

February 1991

A NEW DIMENSION IN TECHNICAL ANALYSIS

THE PURPOSE OF THIS BOOK

FIGURE 1.1

A COMPARISON Of THE WORLD'S THREE LARGEST EQUITY MARKETS: THE UNITED STATES,

JAPAN, AND BRITAIN. GLOBAL MARKETS COLLAPSED TOGETHER IN 1987. THE SUBSEQUENT

GLOBAL STOCK MARKET RECOVERY THAT LASTED THROUGH THE END OF 1989 WAS LED BY

THE JAPANESE MARKET.

was a time when stock traders didn't watch bond prices too closely, when bond

traders didn't pay too much attention to commodities. Study of the dollar was left to

interbank traders and multinational corporations. Overseas markets were something

we knew existed, but didn't care too much about.

It was enough for the technical analyst to study only the market in question. To

consider outside influences seemed like heresy. To look at what the other markets

were doing smacked of fundamental or economic analysis. All of that is now

changing. Intermarket analysis is a step in another direction. It uses information in

related markets in much the same way that traditional technical indicators have been

employed. Stock technicians talk about the divergence between bonds and stocks in

much the same way that they used to talk about divergence between stocks and the

advance/decline line.

Markets provide us with an enormous amount of information. Bonds tell us

which way interest rates are heading, a trend that influences stock prices. Commodity

prices tell us which way inflation is headed, which influences bond prices and

interest rates. The U.S. dollar largely determines the inflationary environment and

influences which way commodities trend. Overseas equity markets often provide

valuable clues to the type of environment the U.S. market is a part of. The job of

the technical trader is to sniff out clues wherever they may lie. If they lie in another

market, so be it. As long as price movements can be studied on price charts, and as

long as it can be demonstrated that they have an impact on one another, why not

take whatever useful information the markets are offering us? Technical analysis is

the study of market action. No one ever said that we had to limit that study to only

the market or markets we're trading.

Intermarket analysis represents an evolutionary step in technical analysis.

Intermarket work builds on existing technical theory and adds another step to

the analytical process. Later in this chapter, I'll discuss why technical analysis

is uniquely suited to this type of investigative work and why technical analysis

represents the preferred vehicle for intermarket analysis.

World Equity Trends

Reproduced with permisson by Knight Bidder's Tradecenter . Tradecenter is a registered trademark of Knight Ridder's Financial Information .

THE PURPOSE OF THIS BOOK

The goal of this book is to demonstrate how these intermarket relationships work in a

way that can be easily recognized by technicians and nontechnicians alike. You won't

have to be a technical expert to understand the argument, although some knowledge

of technical analysis wouldn't hurt. For those who are new to technical work, some of

the principles and tools employed throughout the book are explained in the Glossary.

However, the primary focus here is to study interrelationships between markets, not

to break any new ground in the use of traditional technical indicators.

We'll be looking at the four market sectors—currencies, commodities, bonds,

and stocks—as well as the overseas markets. This is a book about the study of market

action. Therefore, it will be a very visual book. The charts should largely speak for

themselves. Once the basic relationships are described, charts will be employed to

show how they have worked in real life.

Although economic forces, which are impossible to avoid, are at work here, the

discussions of those economic forces will be kept to a minimum. It's not possible to

do intermarket work without gaining a better understanding of the fundamental forces

behind those moves. However, our intention will be to stick to market action and keep

economic analysis to a minimum. We will devote one chapter to a brief discussion

ALL MARKETS ARE RELATED

What this means for us as traders and investors is that it is no longer possible to

study any financial market in isolation, whether it's the U.S. stock market or gold

futures. Stock traders have to watch the bond market. Bond traders have to watch

the commodity markets. And everyone has to watch the U.S. dollar. Then there's the

Japanese stock market to consider. So who needs intermarket analysis? I guess just

about everyone; since all sectors are influenced in some way, it stands to reason that

anyone interested in any of the financial markets should benefit in some way from

knowledge of how intermarket relationships work.

IMPLICATIONS FOR TECHNICAL ANALYSIS

Technical analysis has always had an inward focus. Emphasis was placed on a par-

ticular market to which a host of internal technical indicators were applied. There

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