How inter-market analysis and market volatility can help traders increase their odds of success

IG Asia’s market analyst says that risk management and protecting capital is key for traders to play the long game in investing.

A successful trader in the financial markets has a combination of skill, discipline, and a deep understanding of market dynamics. Professional traders often keep to a set of rules to navigate the complexities of the market and maximise their chances of success.

These include having an extensive knowledge of macroeconomics, a company’s business fundamentals and technical skills. However, in order to increase their odds of success, traders should adopt additional strategies in making trade decisions. 

IG Asia’s market strategist Yeap Jun Rong says that these strategies are mainly centred around risk management, which is the extra key to unlock success for traders. IG Asia is the Singapore arm of IG Group, which is an online trading provider offering access to CFD trading and forex, among others. 

The firm, founded in 1974, is listed on the London Stock Exchange (LSE) and a constituent member of the FTSE 250. Its Singapore arm holds a capital markets services licence under the Securities and Futures Act, and allows investors to trade in more than 250 markets. Most recently, IG Asia has won awards for being Singapore’s number one CFD and forex broker by Investment Trends in 2022 and 2023. 

Since the beginning of this year, there have been three broad market themes underscoring the macroeconomic environment that traders today find themselves in. They are the US Fed’s policy outlook, the US economic conditions, and geopolitical risks and tensions. 

The US Fed’s decision to keep interest rates steady at 5.25%–5.5% on May 2 has been “well received” and “cheered” by the market who see this as a sign that rates will not get more restrictive, says Yeap.

At the same time, the US economy has been holding out relatively well with recovery in areas such as manufacturing. Labour conditions and retail sales are still strong, and consumer sentiments are holding up, Yeap adds. 

“In a way, it hasn’t been screaming any sort of recessionary risks at least for now, and this is generally supportive of a de-risk environment,” he notes. 

Meanwhile, political risks and tensions are taking “more of a backseat”, with little disruption in oil supplies and global trade routes so far. “In a way, markets are starting to look beyond its immediate political risks,” says Yeap. 

Given this climate, traders can adopt a few strategies to complement their trading process. For one, traders can make use of inter-market analysis, which is the technical analysis of the correlations between different asset classes. 

While some financial markets move in tandem with each other, there are others that move in opposite directions. An example would be the price movements of gold and bond yields. 

Gold, which has been gaining a lot of traction as an asset class recently, is a non-yielding asset class. This therefore makes it less appealing when bond yields are high. Furthermore, as gold is US dollar-denominated, a stronger US dollar implies that gold will be more expensive in other currencies, therefore implying an inverse relationship. 

Another example is the relationship between equities and the bond market where typically, high bond yields may translate into some pressure on equities. 

However, the recent US Fed’s policy has led to the inverse relationship breaking down, whereby the S&P 500 has been rising alongside bond yields. This demonstrates that even while using inter-market analysis, there are times where relationships between asset classes may become detached, says Yeap. 

For traders, inter-market analysis can be used as a confirmation of trades. For instance, traders who are keen to buy gold now might find it in their best interest to observe US dollar trends. If the trend is upward, traders can make the decision to buy at current prices, or wait for the US dollar to reverse. 

Inter-market analysis may also be used to find a disconnect in the correlation between asset classes, in which traders could take a long or short position in the hopes that prices will converge down the road. 

Most importantly, inter-market analysis can help traders avoid overexposure in their portfolio. Because the Nasdaq and Nikkei have a strong positive relationship, Yeap says that having a long position in one may impact a trader’s decision to take a long position in the other. “Because you know that if there’s a risk-off move in play, both will actually fall in tandem with each other,” he adds. 

Next, traders can utilise seasonality trading, or the belief that different asset classes perform better at certain parts of the year, as a strategy. Based on the average returns over the past 20–30 years, September has historically been a weak month for stock market returns, says Yeap. 

On the other hand, the Santa Claus rally, where sentiments are generally positive after Christmas and during the first two days of the year, is a seasonality effect that has historically taken place as well. 

Traders should not depend on this fully, but it can help them to align themselves with or against certain seasonality effects, the analyst says. 

Lastly, and perhaps most importantly, traders can use market volatility to their advantage. 

“Generally when there are huge fluctuations in the stock market, it tends to trigger some sense of panic among traders who will want to remove their money from danger,” explains Yeap. However, this may result in traders closing their positions at a loss, purely because they were driven by emotion. 

Taking the CBOE Volatility Index or the “fear index” which shows the market's expectation of 30-day volatility in the S&P 500, traders may end up paying a premium for options to hedge against some of their existing positions. 

But volatility is a really natural phenomenon which allows traders to catch their breath, take a look at the bigger picture and reassess the fundamentals again. 

Ultimately, traders need to protect their capital in order to have the longevity to continue, says Yeap. In order to protect capital, risk management has to come into play, he adds. 

“You can have a view on something, for example, three key views on why the US market will go up,” explains Yeap. “But when conditions change or if rate hikes come back and there’s a change in your initial thesis, that is when you have got to admit that you’re wrong, and cut your losses."