Fundamentals that you read about are typically useless as the market has already discounted the price, and I call them "funny-mentals." However, if you catch on early, before others believe, then you might have valuable "surprise-a-mentals."
ED SEYKOTA
All my life I studied geography, politics, economics, and history intensely, believing they are interrelated, and I've used what I learned to invest in world markets.
JIMMY ROGERS
Basically all of my trades are fundamentally oriented.
You are probably thinking "Just great, a series of quotes from famous traders that conflict with one another!" Well as you probably know by now, so what? Isn't flexibility a key requirement for success? Traders employ different methodologies. They all have similar convictions about the importance of empowering beliefs and virtues, how critical it is to control the vices of trading, and the importance of developing their own strategy. Whether you are a technical trader or a fundamental trader, you are still a trader concerned about making consistent profits.
In a previous chapter we talked about some of the technical tools that have served me very well over the years. When I first started trading stocks in the mid-1970s, I was a pure technical trader who didn't care one iota about the "funny-mentals." My belief at that time was that all known fundamental information was reflected in the price, in this instant of time. To a large degree I still believe that; however, there are times when the market gets so wound up in its own continuity of thought that nothing matters except that continuity of thought. There is a point, though, where the market gets so hysterical that it needs more "hysterical" traders. The instant the supply of new traders and/or new entry orders slows, the continuity of thought will collapse, along with the market.
Answer this question: Are you a technical trader or a fundamental trader? The majority of traders will answer that they are technical traders. The primary reason is that it takes less time to understand how a technical indicator works than to grasp the fundamentals. The human eye is very quick at picking up coincidences where the indicator did this, and the market did that. Consequently most traders buy a computer and get a trading program with all the technical indicators built in, and low and behold within a relatively short period of time they are "expert market technicians"!
Becoming an expert on how fundamentals and intermarket relationships might affect price requires an intense amount of study. Heck, there are people who go to college for years to understand the big picture! It is one thing to write a program to perform a mathematical operation on the price, but it is another thing to write a program to include all the different variables that constitute the fundamentals. Whereas the most popular technical indicators are visually appealing and require little thought (to a novice), fundamentals are not visually appealing and require a lot of thought. Much like a Go game.
As I have stressed, there is no right or wrong answer in devising a trading methodology. However, it behooves you to understand some of the rudimentary aspects of the markets you are trading. Every single market is
ruled by internal relationships, to some degree or another. What is the underlying reason that a market will enter into a multiyear bear phase? Why has gold, for example, slowly drifted down for the past decade? What is the underlying reason that markets trend? The underlying reason is that supply and demand are not balanced. One force is more powerful than the other, and consequently the price will trend.
Why does a market trend up? For several reasons: The supply decreased and the demand increased. The demand decreased slower than the supply decreased. The supply increased, but the demand increased faster. The supply remained fixed, and the demand increased. Why does a market trend down? For the exact opposite reasons it trends up. Why does a market go sideways? Because the supply meets the demand so that it is perfectly balanced. What does the price represent? In all cases the price represents the level where demand meets supply, and becomes a number. As a trader, your responsibility is to use every tool and piece of information available to profit from the movement of prices. Technical analysis gives a
trader valuable information, fundamentals give a trader valuable news. It is critical to understand that both demand the profitable trader to think!
Often different markets are interrelated. This is easily observed while simultaneously looking at different charts. For example, recently there has been a correlation between the Japanese yen and the price of crude oil. In a purely technical sense this correlation is easily
understood. That is, if yen goes up, then crude is going to rally. However, the trader who actually understands the fundamental reasons this is taking place is in a position to catch the break in the continuity of thought, possibly before a pure technical trader. When you are trading a market, every bit of understanding that you can apply to that market will help give you an edge.
Is it harder to create a methodology that incorporates fundamentals? Of course! Do novice traders thoroughly understand both? Of course not, because that would take too much work! The amount of knowledge you can bring to bear on any market will be partially dependent upon the extent that you can incorporate fundamentals into your methodology. As you gain experience, your level of general knowledge will also increase, allowing you to incorporate more knowledge into your methodology.
When a market begins to move in a particular direction, it does so for a technical and/or fundamental reason. Paradoxically when a market has a valid fundamental reason to change direction, it will often initially ignore that fundamental. In other words, if there is a rip- roaring bull market, technical analysis will tell you that the market is in a solid up trend. However,
the fundamentals could be telling you that these high prices are not the reflection of solid demand from real users of the commodity; instead, speculators are buying the commodity only because the price went up in the past. Thus the market is being propelled higher out of a basic human vice, greed. Unless something happens to change the demand/supply equation, the constantly increasing prices are eventually doomed. What eventually happens is that the continuity of thought is broken, and the prices then plummet. What event fundamentally or technically do you think could cause this break in the continuity of thought?
So do you go short when you realize that the market is demonstrating a high degree of hysteria? You can go short only when your methodology tells you to get short. Now if your methodology incorporates a "hysteria" factor within it, and it is indicating that you should get short, then you would get short. However, I would urge you to realize that often this could lead to substantial losses, since it is very difficult to pick a point right before the crowd stops buying hysterically. It might be more advantageous to wait for the high and to go short after the hysteria, and its related continuity of thought, has broken. Another possibility is to wait for the market to hit a high and collapse, and then attempt to retest the high getting short at that point. Again there is no correct way; you have to create your own technique.
Perhaps a plan to trade using fundamentals and technicals would be to go long as soon as the technical gave a buy signal, and increase the position size as the fundamentals confirm the bullish continuity of thought. Then, as the fundamentals or the technicals (whichever come first) start indicating weakness, lighten the position size and, when one of them turns bearish, go flat.
The more you can understand about a market that you trade in, the more you improve the possibility of making a profit. Does this mean that you must become an expert? Depends on you, and how your methodology evolves. I suspect that the more you know about the commodity, the more you will enjoy trading it. The more you understand fundamentally
about how certain events affect the commodity you are trading, the larger your "edge" becomes.
This extra knowledge takes on considerable importance at market turns. Many times when the market is beginning to turn, your methodologyif it is strictly based upon technical factorswill get you into trades that subsequently fail, resulting in a loss. Now if, while you were creating your methodology, you included a component consisting of fundamental factors, then as the market begins to change the subsequent technical signals will be counterbalanced by the fundamental components of the
methodology. By ignoring these subsequent signals, you prevent yourself from being stopped out repeatedly. The trick here is that the fundamental picture will change a little differently each time.
I urge you to learn as much as you possibly can about all the inter- and intramarket relationships in every market you trade in. For example, if you are trading soybean oil, do you know how coconut oil might affect soybean oil prices? If not, perhaps you might want to read up on that interrelationship. Perhaps your trading methodology will not even consider fundamentals; that is fine. After all, your methodology represents your unique perspective on the market. Even if your methodology has no fundamental component, I urge you to become aware of the key fundamentals about the contracts you are trading in. If for no other reason, the additional knowledge will help you enjoy trading a little bit more. In Appendix B you will find a list of Internet sites that you can visit to help increase your level of fundamental knowledge. As I look at a wide variety of markets, I enjoy visiting a variety of Web sites to get news. A trick that I have found is to read the Internet version of foreign newspapers. This helps me realize on a daily basis that even though the United States is a vital part of the overall global economy, there are other perspectives that carry a lot of validity. These foreign perspectives are quite naturally affected by the developments within their countries, and worldwide. Consequently the price movement of a market that I am trading in, or a related market, will be affected by international factors. How was this knowledge beneficial? Let me give you an example. In 1997 the Malaysian currency devalued, and this affected the value of the currencies of nearby countries. The devaluation dramatically increased the cost of Malaysian imports and lowered the cost of exports. Two commodities I was trading that were affected were crude oil and soybeans.
Without going into all the reasons why, it became very apparent to me that the price of crude would have to drop, and the price of soybean oil would also have to drop. Consequently I waited for these two commodities to give me a sell signal using my methodology. The ability to wait for the sell signal depends on how strong your virtues are. My success was that the fundamentals gave me a clear signal on decreasing demand with the supply not being affected, indicating lower prices. My primary technical methodology then gave me my exact entry point.
The more you learn about fundamentals, the more profitable you will become.
Understanding the "big" picture will also give you the confidence to stay with a trending market longer.