“Managing money is real life, not some bullshit strategist fantasy world” – Martin Taylor, Market Wizard

Let’s face it: technical analysis & charting is seductive. Rarely do aspiring traders sit back and rationally ask themselves “what is driving price up & down my charts”. Usually, the only thing they are interested in is “what is the best indicator to use here & now to make money”.

Other objections I receive frequently are  “I don’t understand fundamentals and I don’t have the time to study them” or “doesn’t price reflect all available information and thus make fundamental work redundant?”.

Let me tell you now that all successful market participants I know & interact with all use fundamental analysis in some fashion. And after reading this article hopefully you will also be convinced of it’s usefulness.

What Generates Buying & Selling Pressure

Going back to the essentials: the price of an asset fluctuates based on buying pressure and selling pressure. What generates this pressure – as Edwards & Magee spelled out in plain English back in 1948 – is:

  • the differing value opinions of many orthodox security appraisers
  • the hopes and fears and guesses and moods rational and irrational, of […] buyers and sellers, as well as their needs and the resources

 Price has & always will move based on investors’ decisions in response to a complex mix of psychological, sociological, political, economic and monetary factors. Fundamental analysis, from a trader’s perspective, can mean nothing more than being aware of these influences. Technical analysis, instead, attempts to measure the strength of these drivers and to forewarn of potential changes.

In other words: price tells us what the aggregate perception regarding the future of the currency pair is.  We’re observing expectations regarding future outcomes.

How Expectations are Formed

 “I am not well qualified to criticize the theory of rational expectations […] because as a market participant I considered them so unrealistic that I never bothered to study them” – George Soros, Market Wizard

 The evolution of fundamentals over time is what drives buying & selling in financial markets, so understanding fundamentals can help traders decipher how the market could react to certain economic events. These events can come in many forms:

– headline data prints (for example, central bank decisions, Non-Farm Payrolls, PMI reports, etc.)

– themes (for example, monetary policy divergence between the USA and the Eurozone, weakness in the commodity sector, etc.)

The evolution of the themes which the market is currently focused on goes hand in hand with the evolution of participants’ mindset – and this is what creates the reaction.  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 releases/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.

But which fundamentals contribute to forming expectations, and why?

Stylized view of the FX Market Structure

Source: Proprietary Illustration

Who can “force” the FX market in a certain direction? Who has the most influence?  The answer of course is Central Banks and Treasury Heads. All it takes is the Bank of Japan to be “actively checking prices” at their agent banks for the word to spread along the grapevine and spook market participants into buying Jpy pairs. Or what about the “sure thing” trade, buying EurChf at 1.2000 just because “the SNB had pledged to defend the Swiss Franc from further appreciation”? That was a very common trade for many participants at various levels of the “FX food fhain”. Professional money managers were caught in the onslaught that followed the SNB’s decision to eliminate the “floor” in EurChf. Central Banks can really dictate the weather, in FX.

With this in mind, which fundamentals do you think matter to the people that matter? What do the policy makers base their policies on?  The list certainly encompasses:

– interest rates (yields)

– inflation (growth)

– Employment/Housing/Mortgages

– Capital Inflows/Outflows (directly correlated with the various Equity Indexes)

– Imports/Exports

By now, you’re probably thinking “how can a single retail trader keep track of everything?” Here’s the key: the market is made up of humans and humans cannot possibly keep track of all variables at the same time. So what happens is that the market focuses only on a few themes and stories at any one time.

Follow the Flow of Fundamentals

Source: ForexFactory.com

One of my own habits is to check the economic calendar first thing in the morning (to make sure I’m aware of the events for today) and last thing in the evening (to make sure I’m aware of the events during the Asia-Pacific session that may impact open positions, and a glimpse of tomorrow’s events). These market movers are telling us something about the economy so all investors are interested.

Once you verify that there are important events on tap, be sure to look at what the market is expecting.

Forecast vs. Previous will illustrate the market’s general expectations towards the data

Source: ForexFactory

Please note that I am not suggesting trading ahead of the news. I believe that to be a negative-sum game. It is possible to trade the reaction to the news. But to understand the reaction, all the previous preparation work needs to be in place. Also, remember 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;

– if the market is in an uptrend, then a negative surprize will probably have the largest temporary impact, but might also be ignored as the week progresses;

– if the market is in a downtrend, then a positive surprize will probably have the largest temporary impact, but might also be ignored as the week progresses.

The questions that can assist in creating a functional context for traders are for example:

  • 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?

Follow the Flow of Themes

The market is driven by a never-ending flow of information and data. Following the data prints requires only an Economic Calendar. But how is it possible to follow the various themes that the market focuses on? Starting from scratch, we need to have a clear view of:

  1. where we are coming from
  2. where we were going (which is also where we will most likely go if no new information hits the market)

Where are we coming from?  A useful resource would be and end of week market wrap or news article like the ones we post in the Trading Tribe Chatroom. For example:

Source: Lloyds Bank Economic Research

The objective is to simply “insert yourself into the flow” initially, and take a glance at the main drivers from the past week. The key questions are:

– what has happened in the past week?

– how did the markets react?

b) Where are we going? Again, end of week market wraps (for a weekly view) and news articles (for a daily view) are a good place to search for the right information. As traders, we are not concerned with in-depth analysis. We need to trust the work that has been done by the bank analysts and we simply need to pay attention to what is being reported.

Source: DanskeBank Research

There lies the subtle difference between trading what you see and trading what you believe. In order to trade what you see, you must only pay attention in a mindful, non-judgemental manner.

 To Trade or Not To Trade

“If most traders would learn to sit on their hands 50 percent of the time, they would make a lot more money.” –  Bill Lipschutz, Market Wizard

One unexpected benefit of keeping tabs on fundamental output is also a much keener appreciation of the risks surrounding any given trade. Charts will not tell you this but I think everyone will agree that there is a difference between:

  • preparing a fresh bet on GbpUsd on Super Thursday (when the Bank of England decides it’s monetary policy stance, and issues the Quarterly Inflation Report)
  • preparing a fresh bet on GbpUsd on a Tuesday with only Construction PMI on the docket
  • preparing a fresh bet on GbpUsd without any influential data on GBP or USD.

So many traders tend to overtrade without even knowing it. They get lured into technical setups without paying due attention to the background surrounding their bet. So here is my own general rule:

if there is news that can significantly impact my targeted asset, stay flat and wait until the dust has settled. There will always be another tradable move.

Over to You

Fundamentals influence investor expectations and cause reallocation of capital. By following the themes and events that drive the markets, you are in a much better place to understand and generate context around market moves.

Keep it simple: you don’t need to go in-depth about the market moving news. Just try to understand what the event is about, why it’s important and what is expected.  Also, if  the upcoming event could really change the landscape, then perhaps hold fire and wait until after the event (evaluate the market’s reaction and see whether it’s tradable, or just wait for further information).

A trader that uses both technical & fundamental analysis is like a boxer fighting with both arms.

Good Luck!

About the Author

Justin Paolini is a Forex trader and member of the team at  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.