When people find out that I trade for a living, the first question that usually follows is, “So what stock should I put my money into?” I usually respond with, “Why would you assume you should put money in stocks?” Most investors and traders have been so programmed to believe that investing depends solely on the fortunes of the stock market and they ignore possibilities in other asset classes.
One of the common characteristics I have seen in our successful students at Online Trading Academy is that they are experienced in trading more than one asset class. There are plenty of options for trading profits and also for protection of your investment portfolio in alternative assets. You just have to know where to look.
In the financial markets, there are five asset classes that we can invest in or trade:
1. Cash or cash equivalents such as short term T-Bills and CD’s.
2. Fixed Income products such as Treasury Notes and Bonds or Corporate Bonds
3. Equities and ETFs (commonly known as Stocks)
4. Commodities (Gold, Oil, Copper, Lumber, Soybeans, etc.)
5. Currencies (US Dollar, Euro, Pound Sterling, Yen, etc.)
By understanding the relationships between these asset classes and their cycles in relation to the broad economy, you can find profitable opportunities in nearly any market environment. For instance, when the US Economy was falling in the credit bubble burst of 2008, investors were panicking during the beginnings of the bear market. I saw opportunity. Those savvy traders and investors who understood the inter-market relationships between the asset classes found great deals by buying bonds and commodities. Look at the chart below and see some of the associations between the asset classes.
In the chart, we see the equities market represented by the S&P 500 shown by the red line. The blue line shows commodity prices reflected by the CRB Index. Notice how the commodities and equities have an inverse relationship. When we see a peak in one class, a rally usually forms in the other. Knowing these key relationships can allow you to identify when a market is ready to turn and therefore allows you to shift funds to the asset class that will make you profits. We also see that bond prices tend to move with commodities in times of equity market panic, (the bond yields will move with equities.) The US Dollar will normally move with equities except in this environment and therefore the opposite of commodities. It doesn’t matter if you are a trader of Forex, Equities, Options, or Futures, these relationships affect you!
This knowledge can give you the edge to spot major shifts in the markets. Identifying the danger and understanding the environment you are trading or investing in is a key portion of risk management and can be as important if not more important than simply setting stops. There are key relationships between all of the asset classes and ways to identify the rotation. If you are not familiar with them, I suggest you visit your local Online Trading Academy and enroll in the next course. Even if you are a short term trader, these courses will enlighten you to the macroeconomic forces that move the markets. Understanding these forces is an essential skill to profit from trading them.