For those traders who want a clear and
brief explanation of various concepts often
touched on in technical analysis and trading,
we offer Traders’ Notes.
Intermarket analysis, one of the pillars
of technical analysis, is the comparison
of the price action of one market to
another. This comparison can be as
simple as placing two different charts
side by side. The most widely endorsed
use of intermarket analysis hails from
the Dow theory, whereby the movement
of the Dow Jones Industrial Average
(DJIA) is compared with the Dow
Jones Transportation Average (DJTA).
The theory holds that if both averages
are trending higher, the investor should
conclude that the underlying fundamentals
driving the stock market are sound
and that the trend of the market is up.
When one of the averages begins to
diverge — for example, one average
trends to higher highs, while the other
average fails to make a higher high — a
warning is signaled (Figure 1) but not
necessarily a reversal, as the markets
may get in gear at a later point. The key
is that intermarket analysis can aid the
investor in determining the trend of the
market as well as alert the investor to a
potential trend reversal.