Intermarket Divergence – A Robust Method for Signal Generation

About the Author Murray Ruggiero

Murray Ruggiero is the chief systems designer, and market analyst at TTM. He is one of the world’s foremost experts on the use of intermarket and trend analysis in locating and confirming developing price moves in the markets. Murray is often referred to in the industry as the Einstein of Wall Street.He is a sought-after speaker at IEEE engineering conventions and symposiums on artificial intelligence. IEEE, the Institute of Electrical and Electronics Engineers, is the largest professional association in the world advancing innovation and technological excellence for the benefit of humanity. Due to his work on mechanical trading systems, Murray has also has been featured on John Murphy’s CNBC show Tech Talk, proving John’s chart-based trading theories by applying backtested mechanical strategies. (Murphy is known as the father of inter-market analysis.)After earning his degree in astrophysics, Murray pioneered work on neural net and artificial intelligence (AI) systems for applications in the investment arena. He was subsequently awarded a patent for the process of embedding a neural network into a spreadsheet.Murray’s first book, Cybernetic Trading, revealed details of his market analysis and systems testing to a degree seldom seen in the investment world. Reviewers were universal in their praise of the book, and it became a best seller among systems traders, analysts and money managers. He has also co-written the book Traders Secrets, interviewing relatively unknown but successful traders and analyzing their trading methodologies. Murray has been a contributing editor to Futures magazine since 1994, and has written over 160 articles.As chief systems designer, Murray digs into the depths of niche and sub-markets, developing very specialized programs to take advantage of opportunities that often escape the public eye, and even experienced high level money managers.

  • Alex says:

    What about between 2012 and now? Does it work? Because many systems no longer work. S&P 500 and bonds have long negative correlation durinf previous years.

  • Intermarket Divergence , because it requires divergence is more robust and volatility of equity will increase when correlation a weak, but it will not fall apart completely. You also could add a correlation filter to a model and deal with this issue. I’ve attached the performance report (through 3/30/2015) at the very bottom of the article.

  • Alex Argyros says:

    Thanks, Jeff. Great work.

    I was wondering why you chose 60 minute charts for ES and YM. Would other time frames work with the moving averages you used?

    • Thanks. Murray created a great free tool. I doubt other timeframes would work with the periods I used for the 60-minute chart. I picked a 60-minute chart because 1) I wanted an intra-day chart 2) I know the smaller the timeframes, the more noise there is thus, it’s more difficult to build a system. So, I just picked 60-minutes. If you do move to other timeframes, it would be best to optimize the look-back periods on both SMAs.

      • For those wondering about the 60-minute chart Alex and I are talking about, I’ve created a demo video where I use the Intermarket Divergence tool on the ES vs YM. See it here.

  • rob says:

    Just watched the video. I see that the 2 moving averages have different lengths. Could you not just put a second moving average(the one on YM) on the ES get the same results? You would get moving average divergence doing that instead of using a second symbol to do that.

    • This would be best answered by Murray, as he is the creator of both the concept and code. Here is my $.02 however. You could use two moving averages with one instrument, but all your information for taking that signal is coming from on market – your tradable. In this case we are actually using another market to signal trades. In other words, we are using data not directly related to the current price of the traded instrument. This might be analogous to using volume or $TRIN to generate signals instead of just relying on the price of the tradable.

    • No , This is truly controlled by the intermarket relationship. I have tested many different intermarket relationships for example Tiffany stock on intra-day data leads S&P500. I normally use 45 minute bars for the S&P500. Some currency pairs also lead the S&P500 on a daily as well as a Intra-day basis. Another classic example is the one in the manual trading US versus UTY. If we just use two different lengths for US (thirty year treasury daily data) even selecting the most profitable combinations will still make about 120K less than using the intermarket UTY. That is about a 40% decrease in profit and the results are a lot less robust.
      I have a professional version which allows you to filter out times when the correlations decouple and generate 100% mechanical signals.

  • Allen Z says:

    “Bond prices generally are positively correlated with the S&P 500 ” – Did I miss anything here? Shouldn’t they be negatively correlated in last twenty years? Which time scale was your correlation based on? Thanks.

    • At times they are negatively correlated but the truth is divergence between bonds and stocks since 1971 when we completely went off the gold standard have been positively correlated.

      Negative correlation occur during black swan events, in those cases bond prices go up and stocks go down.

  • MikeMurf says:

    Hi Jeff

    Great blog – Thx for sharing.

    A thought. Would the same/similar results be achieved by using 31MA on S&P & 11MA on S&P? In other words leave out the DOW completely. My thought is that the results are more linked to the difference in MA’s rather than any divergence between S&P & DOW. Does that make sense?

    • If you don’t pick a good intermarket a reliable one you could see the intermarket not outperform by much.
      In my Intermarket Divergence Professional Product, you can select the markets you are trading and up to 50 intermarkets and use the optimizer to optimize not only the moving average lengths but also the markets. You can run an experiment and select 20 different positively correlated markets limit in TradeStation is 50, include Bonds,Currencies,Sectors,Other stock indexes and find which ones are more predictive. The way I do this is I will look for how many times a given market appears in the top 20 sets of parameters. Often times you will see 17 or 18 of the top 20 sets of parameters will be made up of only 1 or 2 markets.

      • Sam says:

        Good, but do you consider data-mining issues? if you have 50 intermarkets it is highly likely that the correlation you end up with and the system as a result are spurious.

        I suggest something you are not of course obliged to do: Post here the results of your best intermarry divergence system for in sample and out of sample. Then we can have a base for more serious talk. I strongly believe these are spurious systems. No offense intended.

        • See the answer is no, If you have 50 intermarkets for example and 15 out of 20 of the top sets of parameters are the same market,you pass any statistical test for significance you need. In addition for this best 1-2 markets , you also run out of sample testing, 3D analysis.
          I am not sure that you understand the significance of the paper Jeff linked to of mine. That was given at IEEE, Cifer in 2012, it covers out of sample testing, analysis of 3D space ect. It shows two different markets for trading bonds one reliable and one which should be reliable but is not and we predicted this issues for that market in 1998.
          We also show a system which was published in 1998 and has traded real walk forward with the same parameters since. This is peer review academic conference associated with IEEE.
          See Intermarket analysis is even less data mining because I would only put in markets which I can logically think would be predictive. If we were trading the Canadian dollar, we could use Canadian stock indexes and various commodities but for example I would not use Coffee.

          • Sam says:

            You paper is fine in terms of demonstrating a method for optimizing parameters but you have not proved that your intermarket method can generate excess returns over and above a method that uses only one of the correlated securities. Our analysis shows that your method cannot generate the excess returns required to discount redundancy. Can you provide proof that the method generated the excess returns? If not, it is not really useful and largely redundant.

  • First , can you share your research. Has it been published peer review. I been using intermarket analysis for over 20 years and trading systems which I developed in the mid 1990’s still work today. I totally disagree with you, bonds have been in a great bull market for 20 years and this system still makes money on the short side. In addition , this is not the only intermarket relationship that works. For example Silver,Chemical Stocks are negatively correlated to bonds and produce good results also. Silver performs better than gold. There are many different intermarket relationships for many different markets. I will cover these in future articles. This is not data mining, I don’t use relationships I can’t explain. For example , even though it works reasonably good , I won’t trade silver using soybeans, because there is not a good premise there.

    • Sam says:

      You have not even provided evidence that your method can generate higher returns as compared to trading only one of the correlated securities. More importantly you did not provide standard measures of returns such as the CAGR that allow making comparisons. The burden of proof is on you to prove that your method is sound, not on your readers. Asking your readers to present data to prove that you are correct is not the best way of doing things. Until you provide the data that show that your intermarket method can do better than a simple crossover I can assume that it is not working as advertized. This is what our analysis shows and we do not care about peer review. Pleas note that nobody who is serious in the industry compares absolute profit numbers. You have to present accepted measures such as the CAGR and MAR. Thank you.

  • Samuel says:

    Thanks Ruggerio and Jeff for publishing this. I have made a couple of valid systems out of this. I couldnt get the Indexes to work but found a solid edge in a couple of Bond markets.

    • Glad to hear it Samuel! The indexes are probably not the best example. But you’re right that bonds can work great.

  • Mark says:

    I don’t think he’s asking you to share research to show he is correct, Sam: he’s asking you to share your research claiming he is incorrect. I think he has every right to ask for that.

    By the way, my gut says intermarket divergence is bunk and the fact that Murray is selling a product here doesn’t help. However, I think there would be a great deal of value in a peer-reviewed article. I am going to take a read through the IEEE paper.

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