Traders are generally of two breeds with each being at very opposite sides of the trading spectrum. The chartists employ technical analysis to study price and market action by using various charting instruments as a vehicle to price forecasting. Technical analysis considers only the actual price behaviour and assumes all relevant factors have been already factored in to the price of the asset.
Their natural enemy, the fundamental analysts say that not all price movements have factored in all relevant information. Fundamental analysis states that markets may, from time to time, mis-price an asset in the short term but that the correct price will eventually be reached. Problems can be easily seen in both types of analysis, technical analysis uses past prices to predict future prices. This “crystal ball” approach has obvious flaws. On the other hand, fundamental analysis is very timing sensitive, fast and reliable information is needed for profitable results. Anything less than split-second information would lead to traders missing the boat.
So, if both methods of analysis are so flawed, how does anyone make any money? Technicians aim to identify non-random price patterns and trends in financial assets and their man goal is to exploit these patterns. Crystal balls are not entirely accurate, thus the best way to employ technical analysis (tools, instruments and methods are not in the scope of this article) is through effective risk/reward risk management. Forecasting future price movements is risky and when the trader gets it wrong, he/she should close the position and realise a small loss.
When the trader gets it right, he/she should stick to their position(s) and ride the wave of profitability. This will keep the many losses small and the few gains large, thus increasing reward and reducing risk.
Fundamental analysis requires looking at “all” economic and geo-political information for both short term and long term trading. The simplest example geo-political effect on futures markets is the Iraq war, which began in March 2003. At the time, crude oil prices were about USD$25 a barrel. Many insightful and thus successful traders took out long positions in the crude oil futures markets due to the perceived volatility in the oil market that was will be the effect of Iraq oil supply disturbances. Crude oil is currently at USD$90 a barrel. Hindsight is a wonderful thing, having said that, many traders were dead right.
Economics are a major part of what makes the markets tick, demand and supply are the core of capitalist markets. The manipulation of interest rates is key macroeconomic management. For example, when the Reserve Bank of Australia raises their interest rate this has a major impact on the futures currency markets. Generally speaking, the Australian dollar will rise relative to the US Dollar. Why? Due to higher interest now earned in Australia, investors start to park their funds in Australian interest-bearing securities. In order to do so, investors need Australian dollars, thus increasing demand and driving the Australian dollar up.
There are many charting instruments employed by technical analysis and many economic and geo-political factors that make the markets what they are. Having said that, I’ve recently been reading a book called “The New Market Wizards”, by Jack D. Schwager, and what I’ve notice thus far is that the most successful traders use both technical analysis and fundamental analysis. For example, a trader might analyse the markets for entry and exist levels while at the same time looking at any fundamental markets that could move the market in a certain direction. Ultimately, every trader needs to find something, a system, that is suitable to them.
Disclaimers: The views expressed in this article are those of Richard Avery-Wright and is not intended as general advice. This does not constitute a recommendation nor does it take into account your investment objectives, financial situation nor particular needs.