Tuesday, November 1, 2011
Fundamental Analysis vs Technical Analysis vs News Traders
Survey of trading methods-
The key differences:
Financial Statistics vs Price Data vs Reaction to an event
A true Chartist will look for technical breeches in a pattern before going long or short on a trading instrument that is based primarily on price data. By technical breaches I mean breakouts of a pattern, a support or resistance level, or a moving average cross for example. True technical traders see no reason to analyze the news or fundamental event because the chart will reflect the value the market has set. With proper trade management strict Technical Analysis can be very profitable method of managing a trading account.
The real objective in Technical Analysis is not to predict the future direction but to detect a change in the current direction.
One of the greatest errors of traders of any kind is to try to pick a perfect top or bottom which is a guess. A correct diagnosis of the technicals is meant to eliminate the error of top or bottom picking by looking for break-outs of patterns or indicators. Without a breakout nothing has changed.
Another technique that has evolved is by combing several strategies and looking for areas of confluence or where 2 or more indicators agree with each other at a specific point. It isn't very meaningful if there's just one indicator making a change but when several "agree" it can indicate a powerful move. The power of math of confirming a result and it works for traders in the form of finding proper confluence.
You will often here the term holy grail by technical traders. In other words experienced traders are most often trying to convey to other traders that their is no holy grail in technical trading and therefor proper money management has to be employed for technical analysis to work.
Fundamental analysis is on the most part a long term approach where analysis is done on financial statistics to gauge a big fundamental change such as increasing factory orders or lower GDP.
Another such strategy in Forex is to look for changes in
the currencies benchmark rate cycle. The trader would look to go long when the interest rates enter a series of rate hikes and short when the interest rates start a series of cuts.
Wouldn't it have been nice to short the dollar when rates where first cut from 5.25%? Problem is the dollar didn't go down right away - at least not vs the Euro but it did drop pretty good vs the Yen.
Federal Funds Target Rate Historical Chart
Most analysis for Wall Street is on the fundamental side. In fact I was not allowed to write for the website Seeking Alpha because they said my articles are "too technical". I was considered but they continually told me to make my articles more fundamentally based. I have nothing against them - personally I just couldn't do it. You'll find most trading sites are very much on the fundamental side. I study the fundamentals but I believe all trades should be technically based - fundamental traders are just the opposite.
There is some merit to fundamentals even for one that relies on price data. It is clearly beneficial to know the direction of the rate cycle and if the economy is expanding or contracting. By analyzing fundamental data the economic theme can be gauged to some degree of accuracy but nothing involving money is ever perfect in a world of greed and fear.
A News Trader is different than a fundamental trader although some think both are the same - they are not.
A News Trader will trade a reaction to a piece of data - at least a smart one will wait until after it is released. The news in question might be earnings releases, Non-Farm-Payrolls, Employment Data, or perhaps the GDP.
The gauge is the reaction to the data not weather it was to be perceived as bullish or bearish - this involves some charting so it's not strictly fundamental and some will even combine technical strategies to see if a turning point has occured.
If the reaction to the news is bearish at the time of release the trader will short and inversely go long if the reaction is bullish at the time of release. Some wait a set amount of time like 5 minutes to be sure the market got it right and to filter out any knee-jerk reactions.
So the difference to fundamentals is a fundamentalist will develop an economic theme based on data whereas a news trader "reacts" to how the market perceives the data which many times can go against the long term fundamental picture. The news trader therfore is for fast moves in gerneral.
Put another way - Fundamental Analysis is political in nature, advanced Technical Analysis is purely mathematical in nature, and News trading is based on perception. All of them can make you money if they are understood thoroughly.
Since Fundamental Analysis is meant for long term strategies it is most effective for large traders and it is political since any policy change is going to effect the fundamental nature of the market. Policies are what control the financial markets. Technical Analysis is very mathematical in nature and is one that is based on mathematical skill rather than economic knowledge. Technical Analysis can be implemented by smaller traders with tight stop losses - it allows someone with enough skill to work their way up the ladder if they are good enough. News is perception based and trading it is meant for fast traders.
In any case it is at least good to understand the different methods markets are gauged and how to apply them before one makes any kind of financial decision.
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- ▼ November (8)