Fundamentals vs. Technicals: Why Not Both?

Fundamental and technical analysis have been battling for supremacy since the dawn of modern financial markets, but Nick Mastrandrea of Market Tea Leaves, says there’s no reason not to use both.

Back in the long ago 1990’s many analysts and pundits used fundamental analysis as a way and means of determining if a stock was worthy of purchase. They would use the company’s earnings and measures such as P/E ratios, ROI, cost of sales, etc. to decide if the equity was a “diamond in the rough” or a dog. Then a curious thing happened. We had the dotcom meltdown, 9/11, various scandals with some major firms (Enron, MCI, etc.) and the data used for fundamental analysis became questionable as the information came from the companies themselves.

Fast forward to today. Many traders became disenchanted with equities, options, etc., and now trade the futures market where they do not have the issue with malfeasance, scandals, etc. I’m one of those traders. However the built-in prejudice with fundamentals remains. All too often I hear traders stating fundamentals are too difficult to determine or another favorite one is “I trade what I see.” Of course, you do, and you should but to say that fundamentals play no part or are misleading or too difficult is simply not true.

In the futures market, we don’t need to be concerned with earnings that can sometimes be misleading or incorrect. Nor do we need to be concerned with scandals or malfeasance. Has anyone ever heard of a gold scandal? I haven’t. I believe there is a general misconception regarding fundamentals and how they pertain to the futures market. It’s my objective to hopefully clear that up. Imagine if you are going to a country that you’ve never been to before. You fly there and perhaps rent a car. Would you rent a car without knowing the roads or highways? Probably not. In all likelihood you would buy a road map. This is what fundamentals are. Fundamentals are the roadmap for the futures market. They are designed to give you the background on various financial instruments or the who, what, when, where, and why if you will. Would you enter a casino and play a game without knowing the rules? I hope not because if you go to Atlantic City in Chris Cristieland (that’s we New Jerseyans call our state now) you’re going to walk out without your shirt. The same would probably hold true in Las Vegas (sorry Nevada).

NEXT PAGE: Example to Illustrate the Concept

Does technical analysis play a role? Of course, it does. No skillful trader would enter a position without knowing what they want to get out of it nor would they enter a trade without their indicators in the right setup. Fundamentals and technicals both play a role. Fundamentals for the strategic or global view and technicals for the tactical or “how to”. Viewed another way fundamentals determine what kind of market this is. Is it a market that has the potential to grow or gain today? Technicals determine “ok I know it’s a positive market and has the potential to gain; now how will I play it”? “What kind of setup do I need to see before I pull the trigger”?

Case-in-point on Wednesday, September 4, we determined that the market was poised for an upside move. We do this by analyzing other futures instruments to make that determination. Yes, you read that correctly, other futures instruments, which mean this data has no chance of malfeasance or error. In any case, early on in the session it didn’t look like the markets were going to gain, in fact they fell following the heels of the European exchanges. We came to this conclusion because our rules of market correlation say that if the USD and bonds are both correlated and are trading lower, then the indices will advance. The net result was the Dow gained 97 points and the other indices advanced as well.

To be a solely technical trader means that you only want a piece of a move and trust that you will get that move. A piece of a move is very subjective. Some traders will place a trade and only get 2-3 ticks on the move. This is scalping, and for some people, that’s perfectly fine, but to make real money you have to trade a lot of contracts or place a lot of trades and then it becomes overtrading and overtrading only benefits one entity: your brokerage firm. Fundamentals on the other hand take a longer view of things. Fundamental traders aren’t interested in a scalp or scalping for that matter. They look for trends as their thinking is why place a trade and risk my hard earned trading capital for 2 or 3 ticks? They would rather wait for the better setup and really capitalize on the trade. The point is one goes hand in hand with the other.

By Nick Mastrandrea of Market Tea Leaves