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
Oil drops on dollar strength and OPEC+ supply expectations
By Jessica Resnick-Ault
NEW YORK (Reuters) – Oil prices fell on Friday as the U.S. dollar rose while forecasts called for crude supply to rise in response to prices climbing above pre-pandemic levels.
Brent crude futures for April, which expire on Friday, fell 74 cents, or 1.1%, to $66.14 a barrel by 12:45 EDT (17:45 GMT). The more actively traded May contract slipped by $1.08 to $65.03.
U.S. West Texas Intermediate (WTI) crude futures dropped $1.42, or 2.2%, to $62.11. The contract was still on track to be up 4.8% on the week.
The U.S. dollar rose as U.S. government bond yields held near one-year highs, making dollar-priced oil more expensive for holders of other currencies.
“It’s a dicey time – it doesn’t seem like a time to load up on a risk-asset position,” said Bob Yawger, director of Energy Futures at Mizuho in New York, wary of a potential output increase from OPEC and allies at next week’s meeting. Also, the U.S. stockpile report this week showed a surprise build in oil inventories.
Friday’s gains also reflect profit-taking after both Brent and WTI headed towards monthly gains of about 20% on supply disruptions in the United States and optimism over demand recovery on the back of COVID-19 vaccination programmes.
Investors are betting that next week’s meeting of the Organization of the Petroleum Exporting Countries (OPEC) and allies, a group known as OPEC+, will result in more supply returning to the market.
U.S. crude production fell in December, the latest month for which data is available, according to a monthly report from the Energy Information Administration.
Despite talk of tightening fundamentals, the demand side of the market is nowhere near warranting current oil price leves, they added.
U.S. crude prices also face pressure from slower refinery demand after several Gulf Coast facilities were shuttered during the winter storm last week.
Refining capacity of about 4 million barrels per day (bpd) remains shut and it could take until March 5 for all capacity to resume, though there is risk of delays, analysts at J.P. Morgan said in a note this week.
(Reporting by Shadia Nasralla, Additional reporting by Sonali Paul in Melbourne and Koustav Samanta in Singapore; Editing by David Goodman, Louise Heavens and David Gregorio)
Bitcoin set for worst week since March as riskier assets sold off
By Ritvik Carvalho and Tom Wilson
LONDON (Reuters) – Bitcoin was headed on Friday for its worst week since March as a rout in global bond markets sent yields flying and sparked a sell-off in riskier assets.
The world’s biggest cryptocurrency slipped as much as 6% to $44,451 before recovering most of its losses.
It was last trading down 1% at $46,671, on course for a drop of almost 20% this week, which would be its heaviest weekly loss since March last year, when fears over the novel coronavirus caused havoc in financial markets.
The sell-off echoed that in equity markets, where European stocks tumbled as much as 1.5%, with concerns over lofty valuations also hammering demand. Asian stocks fell by the most in nine months.
“When flight to safety mode is on, it is the riskier investments that get pulled first,” Denis Vinokourov of London-based cryptocurrency exchange BeQuant wrote in a note.
Bitcoin has risen about 60% from the start of the year, hitting an all-time high of $58,354 this month as mainstream companies such as Tesla Inc and Mastercard Inc embraced cryptocurrencies.
Grayscale’s Bitcoin Trust, which has seen huge inflows amid the heightened interest in cryptocurrencies and manages almost $33 billion in assets, was down 5.5% versus its previous close at $45.63.
The Purpose Bitcoin ETF, which became this month the world’s first exchange traded fund physically settled by bitcoin, last traded at $7.41 versus a net asset value of $9.36.
Its stunning gains in recent months have led to concerns from investment banks over sky-high valuations and calls from governments and financial regulators for tighter regulation.
(Reporting by Ritvik Carvalho and Tom Wilson; editing by Dhara Ranasinghe, Karin Strohecker, William Maclean)
Sterling knocked back by bond rout and inflation fears
By Joice Alves
LONDON (Reuters) – Sterling fell against a stronger dollar on Friday, retreating from a three-year high touched earlier this week, as a rout in global bond markets sent yields flying and hurt the pound, while the Bank of England warned of inflation risks.
After rising above $1.42 for the first time in three years earlier this week, the pound fell to $1.3890 at 1059 GMT, its lowest since Feb. 18..
Versus the euro, the pound fell 0.1% 87.03, after hitting a 10-day low of 87.30 pence in earlier trading..
Bank of England Chief Economist Andy Haldane warned on Friday of a risk that inflation will prove difficult to keep under control as the economy recovers from the pandemic.
Analysts also attributed sterling’s fall on Friday to a sell-off in bond markets.
Benchmark U.S. Treasury yields vaulted to their highest since the pandemic began, driven by the prospect of accelerating growth and inflation that could trigger a faster rise in interest rates than many expect. Gilt yields also rose sharply on Thursday.
“The aggressive Cable capitulation has seen macro and leveraged players retreating from an increasingly overbought market,” said Jeremy Stretch, head of G10 FX strategy at CIBC Capital Markets.
“The correction came as the UK curve 2-10 flattened by 2bp yesterday and short sterling rallied into the close”.
The pound has strengthened about 2% this year as traders expect Britainâ€™s speedy vaccine roll-out will help the economy rebound from its biggest contraction in 300 years.
Relief over a Brexit trade deal and pushed back expectations for negative interest rates from the Bank of England had also supported sterling.
Sterling was still on track for its fifth consecutive month of gains against the greenback and the euro, with analysts maintaining a positive outlook on the currency.
(For graphic of Sterling monthly performance – https://fingfx.thomsonreuters.com/gfx/mkt/oakperraqvr/Sterling%20monthly%20performance.png)
(Editing by William Maclean)
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