V.17:3 (144-145): Traders’ Notes

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

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.