What You Must Know About Inter-Market Relationships (Part 1 of 2)
It is naive to assume that seemingly unrelated markets move independent of each other. The financial and commodity markets are
littered with relationships that might be helpful for those attempting to speculate on price changes. Further, simply assuming that the historical relationship you once read about in college textbooks is consistently valid is a mistake. At the hands of government intervention, the relationship between many markets has morphed into something unrecognizable to seasoned traders.
Why seemingly unrelated assets are tied together
FOREX traders are familiar with the concept of trading assets in pairs, but the majority of traders don’t necessarily think of asset transactions as pairs trading. However, perhaps they should. Every transaction we make in the financial markets, or in daily life, involves two assets.
It is only possible to purchase a security, or an item, by giving up something else. Further, the item being purchased only has value relative to the asset being forfeited. For example, when you buy a loaf of bread at the grocery store you agree to “sell” dollars to acquire bread. In other words, you are buying bread and selling dollars. The store, on the other hand, is selling bread and “buying” dollars. Keep in mind that we have no way of measuring the value of a loaf of bread without comparing it to the dollar, or some other currency.
In review, when speculators buy a commodity they are essentially selling the dollar to acquire the asset. Accordingly, changes in currency pricing can, and do, have a significant impact on other asset values. Nonetheless, there are an infinite number of other factors determining the market price of an asset; unfortunately, it isn’t as simple as assuming a higher greenback will automatically force all dollar-denominated assets lower but it is definitely something to keep tabs on.
