Merv from Nebraska asks:
Why are the technicals followed more than the fundamentals?
There are a number of reasons that many traders favor technical analysis over fundamental. For starters, fundamental traders tend to be commercial firms; that is, they are involved in the actual production or consumption of a commodity. Technical traders tend to be most everyone else – commodity funds and retail speculators.
Commercials have the best fundamental information on a market. As they are involved in the actual production or consumption of a commodity, they have intimate, day-to-day knowledge of supply and demand. Non-commercial firms often have a harder time getting fundamental information, especially in markets that are more thinly traded.
Fundamental analysis generally requires a longer term trading horizon. Fundamentals tend to change more slowly. A wheat miller, for example, is more interested in his consumption over the course of months or years than in his daily usage. Barring supply shocks, over the long term, the production of a commodity changes incrementally.
Speculators tend to trade in shorter timeframes, and technical analysis may better serve shorter term traders. It’s unlikely that fundamental analysis will tell you where beans may be next week, but technical analysis may do so.
From a practical standpoint, the advance of personal computers and the Internet has vastly increased the charting and analysis capabilities available to the small speculator. For the average speculator, it is easier to learn to read charts and apply technical analysis methods than it is to learn to interpret a USDA Cattle on Feed report, for example.
The widespread use of technical analysis raises an interesting question – does technical analysis work because it actually helps interpret the markets, or does it work because it is widely followed, and thus creates self-fulfilling prophecies for the markets? Whichever it is, I don’t care, as long as it works!
AJ from England asks:
Do you take into consideration the underlying Cash market when trading, and how do you determine the fair value?
I don’t generally follow cash markets when trading for much the same reason that I’m not a fundamental trader. There are a number of reasons I don’t think it’s important to follow cash prices. First, for many markets, cash price information is often difficult for the retail trader to obtain. Second, we’re trading in the futures markets, not cash, so if you’re a technical trader, you want to follow the chart of the market you’re actually trading. Lastly, cash connected firms are constantly following the difference between the cash and the futures price (the basis), and if the basis moves out of line, they have an opportunity to arbitrage between the two markets (buy the cheap, sell the expensive, and profit as they move back in line). As arbitrage opportunities are generally rapidly exploited, the basis tends to stay in line, so I don’t think it’s necessary to follow the cash market to be a successful trader.
Arjan from Sydney asks:
Can we identify support or resistance through increasing volatility? Would this be relevant to certain markets only – ones that are lightly traded?
I think volatility is a very useful tool to analyze the markets. Volatility tends to be cyclical, that is, markets tend to move from periods of high volatility to low, and vice versa. Given this, identifying periods of low volatility give the trader clues as to when volatility may increase, and being able to identify this often gives patterns and trade setups. For my purposes, this is the best use of volatility. I haven’t found volatility to be good at identifying points of support and resistance, although many believe that there is an increase in volatility at market turning points. I give more credence to the idea of volatility contraction and expansion in liquid markets. Actively traded and liquid markets will tend to have a more constant order flow, so changes in volatility reflect the true state of the market. Thinly traded markets may alternate between periods of very thin, directionless trade and periods of extreme volatility, as it is easier to “overwhelm” the market and cause a sudden move. From a practical standpoint, there tends to be more slippage in thinly traded markets, and this slippage often occurs exactly when you don’t want it – when you’re looking to get in or out of the market at those times when volatility expands.
Ibrahim from Dubai asks:
How do you determine when a trend reversal has started?
Let me preface my answer by saying that I prefer to trade in the direction of the trend. I think it’s more reasonable to assume that a trend will continue than to assume it will reverse. It’s difficult to know when a trend will end. In addition, trading with the trend is a way of tilting the odds in your favor. An uptrending market will move higher over time, so the odds of profitable trading will tend to be higher if you trade from the long side. For this reason, I try to be a trend follower. There’s no shame in being a sheep!
There are times, however, when it may be useful to look for trend reversals. If you are a trend follower, it’s often useful to look for reversals in a shorter term timeframe to find entry points in the direction of the longer term trend. For example, if you usually trade off daily bars, look for a reversal formation in a 30 or 60 minute timeframe to enter the market as its higher level trend reasserts itself. I prefer a swing trading timeframe (I look to hold a trade for 1 to 5 days), but occasionally I will stay in a trade longer if the trend continues in my favor.
2011 Scott Hoffman
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