Reader Questions Answered

Fundamental trading vs trading on fundamental information

There appears to be a level of confusion among new traders regarding the meaning of fundamental trading. Let me try to clarify things here.

Fundamental analysis is the use of economic, policy, and income information to determine the value of a market and/or to forecast its future direction. At the top level that means looking at the things like GDP growth rates, interest rate policy, government spending, inflation, consumer action, and many other factors. The idea is to develop an expectation of where the economy and/or interest rates and other elements are heading in order to extrapolate a direction for the market. At the level of individual stocks, we’re talking about earnings forecasting, corporate expansion, dividend policy, mergers, and whatnot. They are used to determine the per share value of a company to see if it is over- or under-valued (presenting a trading opportunity) and/or the direction of future company value.

Trading on fundamental information is something different. This is basically what some refer to as “news” trading. That means trading the reaction of the market to a data release, public speaker, or other news event. There is no real analysis of value here. It is just a very short-term position anticipating the action of the market based on the data – for example, going short after data comes out which is perceived as negative for the market. You could think of it as first derivative trading – trading on the movement in the inputs that go in to people’s fundamental analysis.

I’m not saying one is better than the other. Both are very viable approaches. It’s just important to understand the difference. If someone refers to themselves as a fundamental trader, they are speaking to the first definition. They are not news traders.

There’s one other side of this discussion that should also be mentioned, which is taking positions ahead of data releases, etc. That is neither fundamental analysis nor trading on fundamentals. That’s basically gambling.

By John

Author of The Essentials of Trading