The great Technical Analyst, Martin Pring, had to admit “The more I work with markets, the more it becomes apparent that prices are determined by one thing and one thing only, and that is people’s changing attitudes toward the emerging fundamentals”. Fundamentals cause people to rethink their opinions and hence make decisions. It’s fundamentals that move markets, just not in the way textbooks usually explain them.
Traders that only trade with charts are like a boxer fighting with one arm tied behind his back. A contact of mine once said “send me a chart with a story”. That’s what retail traders should aspire to create: an analysis that takes into consideration the background “story” surrounding that regional currency, stock, index, bond market, gold…anything.
In this article we shall understand how an awareness of fundamentals can really enhance your trading skills.
Who is in the Driver Seat
The evolution of fundamentals over time is what drives demand and supply in the FX market. Fundamental analysis is the process through which we should strive to understand how price could react to certain economic events, and whether there is a predominant psychological skew (bias) in the market that could push prices aggressively in one direction. These events can come in many forms:
- headline data (for example, CPI, Retail Sales, GDP reports, etc.)
- top tier data (for example, central bank decisions or minutes, or NFP)
- themes/stories (for example, “Policy divergence” between central banks or geopolitical tension like the recent issues with Turkey).
The release of data over time, or the evolution of the themes that the market is currently focused on, changes the mindset of participants because it changes their perception of value about the asset in question – and this is what creates the reaction from investors. To be even more precise, it’s not even the release of the data or the event that creates a re-allocation of capital: frequently, it’s the expectation of such events that gets things moving. This is why we frequently say the market is “forward looking”: participants tend to “discount” or “price in” their expectations for future forseeable events.
Example of how elections, government policy, and geopolitical tension can affect the markets.
Geopolitical events like Brexit, elections, or wars are self-evident as key market drivers. But why is the constant flow of headline events (in the form of economic indicators) so important? Economic indicators provide some insight into how well a country’s economy is doing. And while it’s important to know the actual print, usually it’s even more useful to know the market’s expected print – which is usually emotional in nature. Understanding the resulting impact of the actual figure in relation to the forecasted figure is the most important part.
The reaction to the headline event is again based more on what participants are feeling than what the numbers might actually say. The “sentiment” that participants carry with them is based on their assessment of economic reports and current market conditions. It’s all a matter of moulding the most recent report into the greater picture, and pairing up economic strength with economic weakness, in order to exploit these situations.
This isn’t “news trading” per se. Although it is possible to trade the reaction to the news, it’s even more empowering to understand how to select the currency pairs or other instruments that have a strong psychological bias behind them – because it’s easier to trade something that has a chance to move in an aggressive manner.
Which chart is easier to trade? You can bet that there is an underlying reason or narrative that has skewed participants’ psychology and is pushing prices wherever trading conditions are self-evident.
We’ve already written about how to follow the flow of themes previously.
Making Sense of Fundamentals
Here are some tips taken from our Forex Fundamentals Mastery Course.
The first difficulty newcomers face, when trying to stay in contact with the constant stream of information, is staying still. Newcomers tend to get excited over every release and end up attempting to trade anything and everything that “might” cause a reaction. This is folly.
Let’s establish some common-sense guidelines for how to correctly read, filter and act (if necessary) upon the flow of fundamentals that hits the wires every day.
- The first step is to pull up an economic calendar in the morning and take a good look at the market moving events due for the day. This is as valid for FX as it is for Futures, Equites, Bonds as well because these market movers are telling us something about the economy so all investors are interested.
- The second step is to look at what the market is expecting.
By comparing the forecast with the previous print, you can discover whether the market is discounting a better number or a worse number. This can help you plan for possible scenarios, but keep in mind that:
- one data print cannot generally alter the course of a trend, if there is one (exceptions are Central Bank meetings and NFP)
- not every event offers a tradable opportunity
- definitely do NOT trade right before news – that’s called gambling.
There is usually an initial response, called “knee-jerk reaction”, which is short-lived, full of action, and is the place where most traders get chopped up. Then, there is a secondary reaction which happens many minutes up to 1 hour after the release, where traders have had some time to think about the release and it’s at this point that the market decides whether the relase should generate a real move. Was the outcome expected or not? Was it with or against the market’s expectation, and is the market currently moving in a logical fashion?
These are quick questions that can help you digest the constant stream of headline events in an actionable manner.
Hone in on What Matters
The main difficulty, when trying to add “a story” to a chart, is to identify what the market cares about at any given time. So how can we know which market mover is most important? The answer lies in understanding what the market is focused on – what it’s current sentiment is.
Here are some questions to get you on the right path:
- what happened yesterday and did the market care? (a market wrap can give you the answer)
- what is due today? Should the market care? (your calendar plus some common sense should help)
- what are the main themes playing out in the market these days? (bank sheets are useful in this respect, and we have them in our resource section)
Over to You
By now you should realize that price is driven by emerging fundamentals and broader themes. These events can skew the market’s psychology enough to generate strong momentum which makes trading a lot easier.
My invitation is to NOT open your charts first thing in the morning. Instead, start by catching up on overnight developments. What happened while you were sleeping? Did the market care? How does it tie in (if at all) to current happenings or current themes that the market is paying attention to?
Seek to create a chart with a story. Seek to trade the charts that have clearer/more influential stories behind them. This will give you focus and also make your life a lot easier when applying your usual technical tools.
You trading will never be the same, for the better.
About the Author
Justin is a Forex trader and Coach. He is co-owner of www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.
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