Trading Tips

Non-Arguments Against Fundamental Analysis

I’m going to join Adam from Forex Blog in taking on a post at Counting Pips titled The Problem with Forex Fundamental Analysis. Obviously, the focus of these pieces is on forex, but really the ideas apply to pretty much all markets.

The author of the latter has defined fundamental analysis in this way:

Fundamental analysis mainly focuses on the overall state of the economy, interest rates, monetary policies which are basically the economic conditions of a country.

These are three arguments made why having a fundamental analysis focus “will be disastrous”.

By the time you receive economic news it will have already been reflected in the charts.
This will tend to be true if the data is largely anticipated. If everyone expects the Fed to hike rates by 25bp at the next meeting then that is bound to get factored into market prices in advance of it happening. A recent example of this is the rise in the euro following hints from the head of the ECB that there could be a rate hike in April.

This, however, doesn’t not account for surprises where an event or data item is nowhere near market expectations. Those sorts of developments are the ones that produce high volatility reactions.

But it doesn’t take a big variance from expectations to cause a market reaction. Unless the market is 100% sure of something there will remain room for reaction. Think of it this way. If the market is only 75% sure the Fed is going to raise rates at its next meeting, it’s probably only going to price about 75% of the hike into current prices. This is why trades pay such close attention to all the Fed speak so they can gauge the probabilities and factor them in.

Economic data is skewed and biased by those reporting it
This may be true, but I’m not inclined to think it matters. Traders and market analysts tear apart every piece of data they get their hands on to see what’s what. They also have secondary sources of information beyond just that reported by the government. They know when things look dicey and react accordingly.

Everyone reacts the same way to news, producing a herd mentality
This would seem to tie in closely with the question from my Trading FAQs book “Why doesn’t everyone trade in the same direction?” The fact of the matter is, they don’t. Anyone who’s been in the markets long enough has seen plenty of times when the market reacts very strongly in one direction only to eventually reverse. That seems pretty good evidence to me that not everyone is included in the initial herd.

But We Miss the Point Entirely
All of the arguments against fundamental analysis listed above are strongly slanted toward trading off immediate term developments – the data and news that’s just hit the wires. This, though, isn’t fundamental trading. It’s news trading. It’s trying to figure out what the market is expecting and how it’s positioned ahead of time and knowing how best to react to the headlines when they hit. Fundamental analysis is taking the bigger picture view with macro trends and valuations in mind. That’s the complete opposite to news trading.

If you want a reason not to use fundamental analysis in your trading, there’s really one one major one. Because of it’s longer timeframe focus, fundamental analysis is of little use for short-term traders beyond providing of the underlying macro scenario.

By John

Author of The Essentials of Trading