Technical vs Fundamental Trading
Technical or Fundamental? The debate as to which trading methodology to use has been raging for decades.
The pure fundamental trader examines economic data, balance sheets, inter-market correlations, and political developments with a view to determining whether a market is correctly priced. After making a value judgement as to where a given market should be, he or she will aim to take advantage of any discrepancies between the current price and what they deem to be fair value. Fundamental traders are therefore deeply concerned with why a market is moving in a given direction.
The pure technical trader is not as concerned with the underlying fundamentals driving a market, preferring to limit the inputs they look at to data derived mainly from the market price. The pure technician believes that market psychology is the key factor, and that markets trend and reverse in a predictable manner which produces patterns on the charts which can be exploited. The technician has an array of tools relating to trend, momentum, market sentiment, and overbought/oversold status.
While the two approaches to solving the market puzzle may sometimes be at odds and ‘never the twain shall meet’, it would be unwise for proponents of both methodologies to disregard valuable information which could be gleaned from the other camp, i.e. trading in a vacuum. While fundamental traders would be foolish to ignore the powerful trend of a security which doesn’t reflect where they think value ‘should’ be, for example a bear market in stocks which sees prices get cheaper and cheaper, similarly technical traders should also maintain a healthy respect of the fundamentals, particularly those trading over a short timeframe with a correspondingly close stop-loss level. The need for mutual respect on both sides becomes more acute on days when an important piece of news comes out.
Trading on Big News Days
Consider a day trader who trades off of intraday charts and imagine it is just approaching 8.30am Eastern Standard Time on the first Friday of the month when the US Non-Farm Payrolls report is usually released. This piece of economic data often produces an extreme market movement as traders who are typically lightly positioned or flat going into the data release put on new positions based on the number.
If a technical trader gets a buy or sell signal just before the number is released does he or she take the trade and hold the position through the release? It would be very foolish to do so as a number or a revision of a previous number which comes out far from consensus market expectations often sees markets move very sharply from the pre-release price to another level without trading at prices in between. This news-driven ‘gap’ can sometimes see the market suddenly trade significantly above or below one’s stop-loss exit level, creating a much larger loss than allowed for by the trader’s money management rules.
Surely the best strategy here would be to wait until long after the data release before making a trade? The problem with this approach is that one can miss most of the move, buying into a trend when many of the early buyers are selling out. It would be great shame to miss out on what could be one of the best trading opportunities of the month so what should the trader do?
Big moves are often preceded by market ‘traps’
In my opinion, many of the best trading opportunies arise as a result of a false breakout of some kind. Most of the time, this theory applies to the technical approach where for example the breach of a support level fails to see follow through selling and a powerful move unfolds in the opposite direction. I term this set-up as a ‘Bear Trap’. It is these technical traders who have ‘sold the break’ who have become trapped and it their stop-loss buying which ultimately drives the price higher as they exit their losing short positions, heading for the exits at the same time.
In this case however, the traders who have become ‘trapped’ are the fundamental traders who have reacted to the economic data which has just been released. Assume that the Non Farm Payroll number comes out so far away from market expectations that it is implicitly bearish for a particular market and as such generates heavy selling pressure just after the release. However, by the close of the session the news-related decline has been reversed, generating losing open positions for those who sold ‘on the news’. Many times I have witnessed just such a move lead to a very powerful advance which often lasts for several days!
How to profit from big news-related traps
From a trading perspective, I would say that the best way to approach these ‘big news’ days is to wait until after the release of the data rather than taking a position and holding it over the release. What often happens is once the data is released markets often see a knee-jerk reaction as fundamentally-driven traders take a position, particularly if the number is significantly stronger or weaker than the market consensus expectations. However, perversely as it may seem, the markets have a habit of seeing a very powerful movement in the OPPOSITE direction to the initial post-release movement, much to the frustration of those who take a position based on the data. To take advantage of just such a move, I like to follow this three step process.
– Just prior to the release, I record the price of the market I want to trade. This point will be known as the ‘news origin price’ and will be my entry price should the market generate a ‘significant’ movement after the release.
– I then calculate price levels which if hit would constitute a ‘significant’ movement due to the news which would tell me that new money is being committed to the market. I would say that any movement which sees the expansion of the global session range by at least 50% is ‘significant’. I would also consider a smaller expansion of the global session range if it includes the breach of yesterday’s high or low in the process.
– I then wait for the release. If any of the threshold levels outlined above are hit by the close of the session (give or take a few pips) I will look to enter a position in the opposite direction if and only IF the ‘news origin price’ is seen again during the global session. If the market returns to this level having made a ‘significant’ post-release move outlined above, then all of the news-driven traders will suddenly find themselves underwater and it is they who will chase the price higher or lower in stop-loss related buying or selling. If the trade is triggered, I will place a protective stop-loss the other side of the day’s range so far looking to trail it as the trade (hopefully) moves into profit.
As to targets, this naturally depends on one’s timeframe but I would stress that a move of this nature is often good for a 2 to 1 or 3 to 1 reward to risk ratio, if not by the close of the session then certainly over subsequent days. If the trade is triggered I will look to exit at three separate levels (PT1, PT2, and PT3) which I calculate if the trade is triggered. I hold the trade until either the stop level is hit, all of the profit objectives are met, or at 22.00 CET on the third trading day after the entry date. If the trade is triggered on a Friday, I will exit on around the U.S. close on Wednesday.
The U.S. Non Farm Payroll ‘Trap’
Let’s see an example of this trading strategy in action for EUR/USD after the release of U.S. Non Farm Payrolls on 2nd October 2009.
Just before the data release, EUR/USD was trading at 1.4543. The number came out much worse than market expectations (-263,000 vs expectations of -170,000), resulting in a violent knee-jerk sell off which saw a test of the buy set-up level at 1.4480, as can be seen in figure 1 below (green line).
After hitting the buy set-up level at 1.4480, EUR/USD then reversed sharply to trade back at the News Origin price at 1.4543 generating a buy signal with a stop-loss at 1.4479 (just below the session low). Within a few hours the first profit take level (PT 1) was hit at 1.4606 and the stop was moved up from 1.4479 to the breakeven point, thus creating a risk-free trade.
Over the course of the next few days, EUR/USD managed to extend its advance to 1.4763, over 200 pips above the original entry price and at a level which could have generated a profit in excess of 3 times the potential loss.
The next time a significant data release such as U.S. Non Farm Payrolls comes around, look to join a post-release reversal which could last for several days.
I wish you all the best in your trading!
About the author
Howard Friend is Chief Market Strategist at MIG BANK in Neuchatel, Switzerland. He has worked as trader and market analyst for over 20 years and has developed some very accurate proprietary trading systems to time the markets. He is a keen student of market price dynamics, has appeared regularly on financial TV and has lectured and been published widely on his specialist subject of trading strategy development. He is a Member of the Market Technicians Association and holds the Chartered Market Technician designation.
Howard Friend, Chief Market Strategist, MIG BANK
E-mail : [email protected]
Phone: +41 32 722 8454
Economic recovery likely to prove a ‘stuttering’ affair
By Rupert Thompson, Chief Investment Officer at Kingswood
Equity markets continued their upward trend last week, with global equities gaining 1.2% in local currency terms. Beneath the surface, however, the recovery has been a choppy affair of late. China and the technology sector, the big outperformers year-to-date, retreated last week whereas the UK and Europe, the laggards so far this year, led the gains.
As for US equities, they have re-tested, but so far failed to break above, their post-Covid high in early June and their end-2019 level. The recent choppiness of markets is not that surprising given they are being buffeted by a whole series of conflicting forces.
Developments regarding Covid-19 as ever remain absolutely critical and it is a mixture of bad and good news at the moment. There have been reports of encouraging early trial results for a new treatment and potential vaccine but infection rates continue to climb in the US. Reopening has now been halted or reversed in states accounting for 80% of the population.
We are a long way away from a complete lockdown being re-imposed and these moves are not expected to throw the economy back into reverse. But they do emphasise that the economic recovery, not only in the US but also elsewhere, is likely to prove a ‘stuttering’ affair.
Indeed, the May GDP numbers in the UK undid some of the optimism which had been building recently. Rather than bouncing 5% m/m in May as had been expected, GDP rose a more meagre 1.8% and remains a massive 24.5% below its pre-Covid level in February.
Even in China, where the recovery is now well underway, there is room for some caution. GDP rose a larger than expected 11.5% q/q in the second quarter and regained all of its decline the previous quarter. However, the bounce back is being led by manufacturing and public sector investment, and the recovery in retail sales is proving much more hesitant.
China is not just a focus of attention at the moment because its economy is leading the global upturn but because of the increasing tensions with Hong Kong, the US and UK. UK telecoms companies have now been banned from using Huawei’s 5G equipment in the future and the US is talking of imposing restrictions on Tik Tok, the Chinese social media platform. While this escalation is not as yet a major problem, it is a potential source of market volatility and another, albeit as yet relatively small, unwelcome drag on the global economy.
Government support will be critical over coming months and longer if the global recovery is to be sustained. This week will be crucial in this respect for Europe and the US. The EU, at the time of writing, is still engaged in a marathon four-day summit, trying to reach an agreement on an economic recovery fund. As is almost always the case, a messy compromise will probably end up being hammered out.
An agreement will be positive but the difficulty in reaching it does highlight the underlying tensions in the EU which have far from gone away with the departure of the UK. Meanwhile in the US, the Democrats and Republicans will this week be engaged in their own battle over extending the government support schemes which would otherwise come to an end this month.
Most of these tensions and uncertainties are not going away any time soon. Markets face a choppy period over the summer and autumn with equities remaining at risk of a correction.
European trading firms begin coming to terms with the new normal
By Terry Ewin, Vice President EMEA, IPC
In recent weeks, the phrase ‘never let a good crisis go to waste’ has received a large amount of usage. Management consultancies, industry associations and organisations, including the Organisation for Economic Co-operation and Development (OECD) have all used it in order to discuss how the current crisis, caused by the Coronavirus pandemic, presents an opportunity for new and worthwhile change.
The saying is also commonly used to indicate that the destruction and damage that is caused by a crisis gives organisations the chance to rebuild, and to do things that would not have previously been possible. This has the potential to impact financial trading firms, where projects that this time last year would not have made much sense now appearing to be as clear as day. In Europe, banks and brokers alike are beginning to think about what life will look like post-pandemic, and how their technology strategies may need changing.
We can think of three distinct phases when it comes to a crisis. Firstly, there is the emergency phase. This is followed by the transition period before we come to the post-crisis period.
Starting with the emergency phases, this is when firms are in critical crisis management mode. Plans are activated to ensure business continuity, and banks and brokers work to ensure critical functions can still take place so as to continue servicing their clients. With regards to the current crisis period, both large and small European banks and brokers were able to handle this phase relatively well, partly due to the fact that communications technology has reached the point where productive Work From Home (WFH) strategies are in place. For example, cloud-connectivity, in addition to the use of soft turrets for trading, has enabled traders from across the continent to keep working throughout lockdown. From our work with clients, we know that they were able to make a relatively smooth transition to WFH operations.
In relation to the current coronavirus crisis, we are in the second phase – the transition period. This is the stage when financial companies begin figuring out how best to manage the worst effects of the ongoing crisis, whilst planning longer-term changes for a post-crisis world. One thing to note with this phase, is that no one knows how long it will last. There is still so much we don’t know about this virus. As such, this has an impact on when it will be safe for businesses to operate in a similar way to how they were run in a pre-pandemic world. But with restrictions across Europe starting to be eased, there is an expectation that companies will start to slowly work their way towards more on-site trading. For example, banks are starting to look at hybrid operations, whereby traders come in a couple of times a week, and WFH for the rest of the week. This will result in fewer people in the office building, which makes it easier to practise social distancing. It also means that there is a continued reliance on the technology that enables people to WFH effectively.
Finally, we have the post-crisis period. In terms of the current crisis, this stage is very unlikely to occur until a vaccine has been developed and distributed to the masses. Although COVID-19 has caused mass economic disruption, many analysts are predicting a strong rebound once the medical pieces of the puzzles are put into place. It may not be entirely V-shaped, but the resiliency displayed by the financial markets thus far suggests that it will be healthy.
Currently, many European trading firms are taking what could be described as a two-pronged approach.
The first part of this consists of planning for the possibility of an extension to phase two. Medical experts have suggested that there could be some seasonality to the virus, with the threat of a second wave of COVID-19 cases in the Autumn meaning that the risk of new restrictions remains. If this comes to fruition, there would be a need for organisations to fine-tune their current WFH strategies and measures, and for them to take greater advantage of the cloud so as to power communications apps.
The second component consists of firms starting to think about the long-term needs of their trading systems. Simply put, they are preparing themselves for the third phase.
It is in this last sense, that the idea of never letting ‘a good crisis go to waste’ resonates most clearly.
Currency movements and more: How Covid-19 has affected the financial markets
The COVID-19 pandemic has been more than a health crisis. With people forced to stay indoors and all but the most essential services stopped for multiple weeks, economies have suffered and financial markets have crashed. Perhaps the most public and spectacular fall from grace during the early stages of the pandemic was oil. With travel bans in place around the world and no one filling up at the pumps, the price of oil plummeted.
Prior to global lockdowns, US oil prices were trading at $18 per barrel. By mid-April, the value had dropped to -$38. The crash was not only a shocking demonstrating of COVID-19’s impact but the first time crude oil’s price had fallen below zero. A rebound was inevitable, and many traders were quick to take long positions, which meant futures prices remained high. However, with stocks piling up and demand sinking, trading prices suffered. Unsurprisingly, it’s not the only market that’s taken a knock since COVID-19 struck.
Financial Markets Fluctuate During Pandemic
Shares in major companies have dipped. The Institute for Fiscal Studies compiled a round-up of price movements for industries listed by the London Stock Exchange. Tourism and Leisure have seen share prices drop by more than 20%. Major airlines, including BA, EasyJet and Ryanair have all been forced to make redundancies in the wake of falling share prices. The automotive industry has also taken a knock, as have retailers, mining and the media. However, in among the dark, there have been some patches of light.
The forex market has been a mixed bag. As it always is, the US dollar has remained a strong investment option. With emerging markets feeling the strain, traders have poured their money into traditionally strong currency pairs like EUR/USD. Looking at the data, IG’s EUR/USD price charts show a sharp drop in mid-March from 1.14 to 1.07. However, after the initial shock of COVID-19 lockdowns, the currency pair has steadily increased in value back up to 1.12 (June 25, 2020). The dominance of the dollar has been seen as a cause for concern among some financial experts. In essence, the crisis has highlighted the world’s reliance on it.
Currency Movements Divide Economies
In any walk of life, a single point of authority is dangerous. Indeed, if reliance turns into overreliance, it can cause a supply issue (not enough dollars to go around. More significantly, it could cause a power shift that gives the US too much control over economic policies in other countries. Fortunately, other currencies have performed well during the pandemic. Alongside USD and EUR, the GBP has also shown a degree of strength throughout the crisis. However, these positive movements haven’t been shared by all currencies.
The South African rand took a 32% hit during the early stages of the pandemic, while the Mexican peso and Brazilian real dropped 24% and 23%, respectively. Like the forex market, other sectors have experienced contrasting fortunes. Yes, shares in airlines and automotive manufacturers have fallen, but food and drug retailers have seen stocks rise. In fact, at one point, orange juice was the top performer across multiple indices. With the health benefits of vitamin C a hot topic, futures prices for orange juice jump up by 30%. The sudden surge had analysts predicting 60% gains as we move into a post-COVID-19 world.
Looking Towards the Future through Financial Markets
The future is always unknown and, due to COVID-19, it’s more uncertain than ever. However, the financial markets do provide an indication of how things may change. The performance of USD and EUR in the forex markets suggest there could be a lot more trade deals negotiated between the US and Europe. The surge in orange juice futures suggest that health and wellness will become a much more important part of our lives. Even though it was already a multi-billion-dollar industry, the realisation that a virus can alter the face of humanity has given more people pause for thought.
Then, of course, there’s the move towards remote working and socially distance entertainment. From Zoom to Slack, more people will be working and playing from home in the coming years. The world is always changing, but recent have events have made us appreciate this fact more than ever. The financial markets aren’t a crystal ball, but they can offer a glimpse into what we can expect in a post-COVID-19 world.
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