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Should I Incorporate Fundamental Analysis When Trading a System?
There's a common misconception about "Fundamental Analysis": People tend to think that the market should react in a certain way to news. Example: "Unemployment Rate goes down", which means that the economy is doing better, therefore companies should make more profits and stock prices will move up. Conclusion: If the unemployment report is positive, the market moves up.
But in reality the markets are driven by greed and fear, and not by supply and demand or anything like this. A report itself is meaningless: It's the traders reaction to the report that moves the market.
Here's a perfect example: On Friday, April 7th 2006 the unemployment rate for March was published. The market expected an unemployment rate of 4.8%, and the numbers came in better than expected: Only 4.7% (for details see http://biz.yahoo.com/c/ec/200614.html). That's good news, isn't it? The market should move up, right?
WRONG! On that day the e-mini S&P dropped 20 points. Why?
Well. here are some comments I got from a news-service:
"Not surprisingly, Fridayís equity trade was dictated by the March employment report. More specifically, it was the Treasury marketís reaction to it that set the stage for stocks." ...
"A lack of negative surprise caused the stock market to breathe a sigh of relief."...
"The Treasury market had a very divergent reaction to the data, and it took the stock market down with it. For Treasury traders, the in-line data essentially provided no evidence that the Fed will be inclined to soon end its monetary tightening cycle."
Oups. So the stock traders thought it's good news and the market was moving up, but the treasury trader in the other room thought it's bad data. So treasury instruments were rallying, causing the stock market to drop like a rock. But don't stocks lead the treasuries? Or do treasuries lead stocks? ...
As I am writing these lines another news hits the ticker: Oil prices trading above per barrel. But what does it mean? Should the stock market move up or down? Here's a discussion that I heard this morning: "As crude oil prices continue to plug higher the debate over what it all really means will begin again. The questions that will be batted back & forth are "Are sky-high oil prices indicative of a coming economic slowdown or looming inflation?" And more important: How will the Fed react? Will they cease increasing interest rates or even lower the rates again? This would provide a boost for the stock market. Or will traders fear that there's an economic slowdown which might result in lower company earnings? This would move the market down.
As you can see, it's not the news that move the market; it's the reaction of the traders to news that let prices jump up and down.
Now, how should a computer model take these emotions into consideration?
In my opinion there's no way, and I haven't seen any models (incl. artificial intelligence) that is coming somewhat close to this (sometimes really weird) human behavior.
That's why I for one don't incorporate Fundamental Analysis into my trading systems.
About the Author: Markus Heitkoetter is a 15 year veteran of the markets and the CEO of Rockwell Trading.
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