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Intermarket Analysis part 2
Sector Rotation
Unsurprisingly, the business cycle influences the rotation of stock market sectors and industry groups. Certain sectors perform better than others during specific phases of the business cycle. Knowing the stage of the business cycle can help investors position themselves in the right sectors and avoid the wrong sectors.
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The graph above shows the economic cycle in green, the stock market cycle in red and the best performing sectors at the top. The green economic cycle corresponds to the business cycle shown above. The centerline marks the contraction/expansion threshold for the economy. Notice how the red market cycle leads the business cycle. The market turns up and crosses the centerline before the economic cycle turns. Similarly, the market turns down and crosses below the centerline ahead of the economic cycle.
Cyclicals, which is the same as the consumer discretionary sector, are the first to turn up in anticipation of a bottom in the economy. Technology stocks are not far behind. These two groups are the big leaders at the beginning of a bull run in the stock market.
The top of the market cycle is marked by relative strength in materials and energy. These sectors benefit from a rise in commodity prices and a rise in demand from an expanding economy. The tipping point for the market comes when leadership shifts from energy to consumer staples. This is a sign that commodity prices are starting to hurt the economy.
The market peak and downturn are followed by a contraction in the economy. At this stage, the Fed starts to lower interest rates and the yield curve steepens. Falling interest rates benefit debt-laden utilities and business at banks. The steepening yield curve also improves profitability at banks and encourages lending. Low interest rates and easy money eventually lead to a market bottom and the cycle repeats itself.
The two sector PerfCharts below show relative performance for the nine sector SPDRs near the 2007 peak and after the 2003 bottom. The S&P 500 peaked from July to October 2007 and broke down in the fourth quarter of that year. In the summer of 2007, the energy and materials sectors were leading the market and showing relative strength. Also notice at the consumer discretionary was lagging the S&P 500. This section action matches what is expected at a market top.
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The S&P 500 bottomed in March 2003 and began a powerful bull run that lasted until the peak in the summer of 2007. The consumer discretionary and technology sectors led the first move off the March 2003 low. These two showed relative strength that affirmed the importance of the 2003 bottom.
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Conclusion
Intermarket Analysis is a valuable tool for long-term or medium-term analysis. While these intermarket relationships generally work over longer periods of time, they are subject to draw-downs or periods when the relationships do not work. Big events such as the Euro crisis or the US Financial crisis can throw certain relationships out of whack for a few months. Furthermore, the tools shown in this article should be used in conjunction with other technical analysis techniques. The XLY/XLP ratio chart and the Industrial Metals/Bond Ratio chart could be part of a basket of broad market indicators designed to assess the overall strength or weakness of the stock market. One indicator or one relationship should not be used on its own to make a sweeping assessment of market conditions.
Intermarket Analysis article & illustrations courtesy of Stockcharts.com
And still, what is forex trading is all about?
For many people, forex trading is a new way of making money. Some think that it is too hard to make money there. Others think that it is a full scam. There is also a group of people who think that trading is a peace of cake so they put their hard earned money on a trade and lose everything.
Actually, successful trading is a completely different kind of a process. It is not hard to make money by trading. Moreover, it is not a scam. Novice traders should understand that no one in the entire world don’t know what will happen next on the financial markets. Thereby, it is wrong to put all the money on a single trade. The result of this action would be the same as betting on Red or Black on the roulette wheel.
Look at trading as a process very similar to investing. The potential profits that could be made by trading and investing are pretty much the same. They are measured in percentage of the initial capital that a trader is capable to make during a year. Traders are short-term investors. The main difference lies in the increased number of trades that short-term traders open in relation to investors.
Trading is hard to call a business. It is more like investing. The amount of efforts put into trading won’t make a trader richer. What is more important is the amount of money a trader can put into trade to make more money. It is all about profits in percentages. Average traders can double the trading account once in a year. Rarely someone manages to make more than that. Thereby, if a trader has 10.000$ in the initial capital then his goal would be to make another 10.000$. Moreover, he should not even think of making 100.000$. It would only be possible if trading is done with inappropriate money management and a very high risk of losing everything. For example, a trader can make 100.000$ with risk 1:10 to lose all of his 10.000$. However, by trading the right way, without a risk of being burned, it is impossible to make 1000% during a year.
Of course, a trading strategy is also important. If a backtest of a strategy shows less than 100% in a year then it is necessary to keep looking for a better trading system. In fact, there are a plenty of different edges to choose from. Each strategy has its pros and cons and traders should choose which of them to use in their trading. It is very similar to choosing individual stocks into investors’ portfolio. Once a strategy is chosen, it is very important to follow it without any changes to it for a substantial amount of time. That is where trading becomes a boring process but eventually it brings very good profits.
Most excitements traders should feel while researching the market and not while trading it. Trading is just executing signals that have a positive chance of winning. The accuracy of these signals’ execution together with a proper money management is the key for successful trading.
Traders should avoid emotions while trading and keep trading even when strategy shows drawdowns. It is very important to stick to the chosen strategies. Every strategy has its good days and bad days. If a trader decides to change the strategy in a middle of a drawdown then most likely his new strategy won’t work while the old one could get out of scrapes.
To make money by trading forex it is essential to have a plan. First of all, traders should realize how much they can make and what drawdowns could happen to them while they trade. It is necessary to understand before beginning to trade on the forex market so that to avoid stressful situations together with complete frustration. Secondly, it is necessary to choose strategies. It can be just one or several strategies. In a case with multiple strategies, all of them should be traded separately in order to not get tangled with them. Finally, traders should have proper money management. Every trade can easily be lost. Thereby, traders should put 1% or even less of their trading capital into each trade. Higher risks are unacceptable and should be avoided.
In the end, forex trading isn’t that complicated. It is people who complicate it more than it really is. Actually, simple trading strategies perform very well and often even better than complex ones.
There is no need to be a trading guru to make money on forex. Trading is just following the rules that worked in past. That is why, everyone can benefit from trading forex. However, it is not a getting rich quick scheme.
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Dow Jones Industrial Average
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Dow Jones Industrial Average (1900 - Present Monthly) - chart courtesy of stockcharts.com
The Dow Jones Industrial Average, also called the Industrial Average, the Dow Jones, the Dow Jones Industrial, the Dow 30, or simply the Dow, is a stock market index, and one of several indices created by Wall Street Journal editor and Dow Jones & Company co-founder Charles Dow. It was founded on May 26, 1896, and is now owned by Dow Jones Indexes, which has its majority owned by the CME Group. The average is named after Dow and one of his business associates, statistician Edward Jones. It is an index that shows how 30 large publicly owned companies based in the United States have traded during a standard trading session in the stock market. It is the second oldest U.S. market index after the Dow Jones Transportation Average, which was also created by Dow.
The Industrial portion of the name is largely historical, as many of the modern 30 components have little or nothing to do with traditional heavy industry. The average is price-weighted, and to compensate for the effects of stock splits and other adjustments, it is currently a scaled average. The value of the Dow is not the actual average of the prices of its component stocks, but rather the sum of the component prices divided by a divisor, which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index.
Along with the NASDAQ Composite, the S&P 500 Index, and the Russell 2000 Index, the Dow is among the most closely watched U.S. benchmark indices tracking targeted stock market activity. Equivalent indices, such as the FT 30, have largely become redundant in favour of more representative and neutral indicies, such as the S&P 100. Although Dow compiled the index to gauge the performance of the industrial sector within the American economy, the index's performance continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters that could potentially lead to economic harm. Components of the Dow trade on both the NASDAQ OMX and the NYSE Euronext, two of the largest stock market companies. Derivatives of the Dow trade on the Chicago Board Options Exchange and through the CME Group, the world's largest futures exchange company, which owns 90% of the indexing business founded by Dow Jones, including the Industrial Average.
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Some History Of Forex Market
The historical evolution of foreign exchange markets can be compartmentalized into 3 distinct phases namely the gold exchange period, followed by the Bretton Woods Agreement, to its current setting.
The Gold exchange period
The gold exchange standard ruled over international economic system between 1876 and World War I. This was a fairly stable system wherein currencies were supported by the price of gold.
But the gold exchange standard had a weakness of evolving on an all or nothing pattern. For example, when a country’s economy strengthened, that country may import a great deal until its gold reserves may not be sufficient to support its currency.
Consequently this could lead to lesser money supply, escalation of interest rates and perhaps recession. In such a scenario, the rock bottom commodity prices would be a stimulus for other countries to engage in frenzied buying activity until normalization of the economy with decline in interest rates occurred. This worked fine until World War I caused blockage of trade inflows and movement of gold and along with that ended the all or nothing pattern typical of the gold standard.
Bretton Woods Agreement
The Bretton Woods Agreement was cobbled in 1944 to regulate international forex markets as it existed then. The essence of this agreement was to ensure international monetary steadiness and curb speculation in international currencies. As per this agreement, the value of national currencies was fixed against the dollar with the dollar rate set at 35USD per ounce of gold.
Participating countries were required to maintain the value of their currency within a narrow band against the dollar and an equivalent rate of gold.
Consequently the dollar became a sort of reference currency, inasmuch as it signaled a shift in global economic dominance from Europe to the U.S.
Conditions were also imposed on countries prohibiting them from devaluing their currencies in excess of 10%. However post-war construction during the 1950s with intense volume of international trade coupled with massive movement of capital put to naught the foreign exchange rates arrived at in the Bretton Woods Agreement.
With effect from 1971 the US dollar was no longer exchangeable into gold signaling the demise of the Bretton Woods Agreement. Furthermore by 1973, the major industrialized nations' currencies were floated more freely across nations, coinciding with currency prices being quoted daily, together with increase in volume, speed and price volatility of forex deals.
Post Bretton Woods Agreement also saw the emergence of several new financial instruments and trade liberalization. Furthermore with the advent of computers and technology in the 1980s the market reaches for cross-border forex trading gained momentum extending through Asian, European and American time zones.
Gradually foreign exchange transactions increased intensively to all the facets we see today in forex markets worldwide.
Emergence of Eurodollar
Another major factor that speeded up Forex trading was the emergence of the Eurodollar (US Dollars deposited in banks outside U.S) market.
Since 1980s London is reckoned as the key center in the Eurodollar market where U.K based banks lend dollars as an alternative to pounds, and its geographical proximity to both Asian and American markets has allowed the Eurodollar market to flourish as well.