GET Financial Education Series - Futures
Intermarket Analysis – Lesson 14
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The Futures market is the most diverse global financial market. Whilst no other financial market can compare to the diversity of the Futures market, other financial markets do impact on the Futures market. For instance the U.S. Bond market can affect the value of the U.S. Dollar Index Futures contract just as the Japanese yen can affect the value of the Nikkei 225 Index Futures contract.
To become a successful Futures trader you will need to recognise the relationships that exist among the world's financial markets and comprehend how these relationships may affect the Futures contracts you are trading.
Sometimes you can receive advanced warning of what is going to happen in the Futures market by watching what is currently happening in other financial markets. For example if you see the value of the AUD/USD currency pair rising quickly, you can look for a corresponding rise in the value of the Gold Futures contract. Once you know what to look for, you can take advantage of the same correlations that the large institutional investors are watching.
In this section we will be focusing on how the following markets affect the Futures market:
- Forex market
- Bond market
- Stock market
The Forex Market and the Futures Market
The rise of global demand for commodities has tied the Futures market and the Forex market closer together. Virtually every economy around the world has to import some of the commodities it consumes. To buy these commodities importers must exchange their currency for the currency of the economy from which they are importing their goods. This transaction drives the demand for the exporter's currency higher, with a corresponding increase in the value of that currency. This transaction also drives the supply of the importer's currency lower and therefore the value of that currency decreases.
Three of the major currencies - the Canadian dollar (CAD), the Australian dollar (AUD) and the New Zealand dollar (NZD) - are closely related to commodity values because they are major commodity exporters. As the price of commodities rises the value of these currencies typically rises. As the price of commodities falls the value of these currencies typically falls.
Each of these 'commodity currencies', as they are known amongst Forex traders, is correlated with a different commodity. For example Gold Futures are highly correlated with the Australian dollar. As the price of the Australian dollar rises the value of Gold Futures typically also rises. As the price of the Australian dollar dips the value of Gold Futures also dips. While this correlation isn't perfect it is significant.
Futures traders can also buy and sell Futures contracts that directly represent the currencies themselves. You can buy the Futures contract for the Canadian dollar if you think this currency is going to increase in value. Or, instead, you can sell the Futures contract for the Japanese yen if you think this currency is going to decrease in value. Paying attention to what is happening in the Forex market during the next few years could therefore lead you to greater profits in your Futures trading.
Signal Chart
The global Bond market is the second largest financial market in the world. Governments, institutions and individual investors all participate actively in the global Bond market. Each one of these market participants is looking for the same thing - a profitable return on investment.
Government bonds make up the largest percentage of the global Bond market. These bonds are typically viewed as risk-free investments because they are backed by the full goodwill and faith of strong national governments. However not all government bonds were created equal - or achieve equality! Some governments pay a higher interest rate for their bonds than do others. International investors take these interest rates into account when they are deciding where to invest their money. Typically bonds with higher interest rates are more attractive to investors - as long as the economies covering the bonds are relatively stable.
Investors who wish to buy government bonds must buy these bonds with the currency of the represented government. If international investors wish to buy U.S. government bonds then they must first exchange their currencies for U.S. dollars. This increased demand for U.S. dollars drives up the value of the U.S. Dollar Index Futures contract. At the same time the increased supply of some international currencies on the market drives down the value of the Futures contracts for those currencies.
Knowing which governments offer higher interest rates on their government bonds, and likewise which bonds are gaining popularity among international investors, will help you to identify which currency Futures contracts to buy and which currency Futures contracts to sell. Fortunately for you the international bond market rarely changes directions instantaneously. Instead it cycles in longer-term and somewhat predictable trends that you can exploit.
You can also trade Futures contracts on the government bonds themselves. If you see that demand for Japanese or Swiss bonds is increasing, for instance, you can buy the Futures contract for either of these bonds.
Stock Markets and the Futures Market
Individual investors around the world seem to watch Stocks more closely than any other market. Stocks are exciting, they have been around for a while and most individual investors can relate to the companies in which they are buying stock. When stocks are performing well, money from around the globe flows in to buy the 'hot' stocks. When stocks are performing poorly, money flows out as international investors sell their shares.
Futures investors can take advantage of the general increases and decreases in stock markets around the world by investing in the Futures contract representing the indices from the major global stock markets. For instance, to take advantage of a rising stock market in France, a Futures investor can buy the Futures contract for the CAC 40. Likewise, to take advantage of a falling market in the United Kingdom, a Futures investor can sell the Futures contract for the FTSE 100.
Globalization has also made it easier for investors from one country to invest in the stock markets of other countries. If investors see that stocks in the United Kingdom are performing well, they will rush to buy those stocks. If they see that stocks in Japan are starting to outperform stocks in Europe, they may take their money out of the U.K. and put it into Japan in the hope of earning higher rates of return on their investments.
Stocks are priced in the local currency. To invest in stocks in the United Kingdom foreign investors must first convert their currencies into British pounds sterling. This increased demand for British pounds sterling drives up the value of British Pound Futures contracts. As this occurs the increased supply of international currencies on the market, a supply that is disproportionate to demand, drives the value of the Futures contracts for these currencies lower.
Futures investors closely watch how the stock markets in major countries are performing. If the stock market in one country starts outperforming the stock market in another country then Futures investors know that other investors will most likely be moving their money from the country with the weaker stock market to the country with the stronger stock market. This will drive up the value of the Futures contract representing the currency of the country with the stronger stock market. And, meanwhile, the value of the Futures contract representing the currency of the country with the weaker stock market will be depressed. By buying the Futures contract for the currency from the country with the stronger stock market, and by selling the Futures contract for the currency from the country with the weaker stock market, you can potentially make a handsome profit.
The Forex Market and the Futures Market
