The Most Important Technical Indicator is… Fundamentals

Boris Schlossberg

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I am a technical trader. I trade price on the 1-minute chart, which is about as granular as you can get without becoming a high-frequency scalper. I couldn’t care less about Fibonacci levels, Gann angles, Elliott waves and any other geometric structures that traders try to graft onto what is essentially a never-ending price auction. If those tools work for you – all the more power to you – but I like to operate in the here and now, where my sense of the future is never more than an hour long.

I have a great new algo, called Trendy that we developed in my chat room and I am very happy to follow its signals. But Trendy, like all robots it is just an execution algorithm. Like a hunting dog, it can follow a scent but it can’t tell you if that scent will lead you to a dirty old sock or a murder weapon. Like all algos it needs to be turned on and off. It needs to be properly positioned. It needs to be … managed.

Just for fun, I let it run 24/5 on a demo account and watch it bleed money hour by hour, while I collect 20-30 pips most every day judiciously deploying five to ten times each day.

But much as I believe in the tactical value of trading price, the other day I realized that the single most important input into Trendy’s success is actually … fundamentals. Today, for example, the market gave me three good Trendy trades – a short AUDUSD off a meh RBA interest rate statement, a long USDJPY off the burst in US yields and a short GBPUSD off Jamie Dimon’s letter about the perils of Brexit. All else was garbage, as prices weaved and bobbed and dropped and chopped producing lots of heat but little light as they say the American South.

Technical analysis tells us what IS happening. Fundamentals tell us WHY something is happening. Understanding the WHY gives us the confidence to predict that the price action in the near future. Especially if we’ve seen that pattern of behavior hundreds of times before.

Does it work all the time?

Of course not.

Another story could come by and bump our analysis out of the way. Or some large, non-price sensitive order could disrupt market flow completely and stop us out. However, on balance, this approach works 70% to 80% of the time with reasonable risk-reward ratios. That’s because instead of segregating technicals and fundamentals into two disparate disciplines, this methodology tries to synthesize the two and treats them as two sides of the same coin.

To make a successful day trade you need two things – the price action to be moving your way and news flow to continue pushing prices it in that direction. Trading, after all, is very simple. It’s the act of predicting that price will either continue or reverse.

So instead of having never ending debates as to which method works, isn’t it better to always be aware of both technicals and fundamentals at any given moment in time so that we put the odds in our favor and make more accurate trades?

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What’s Better – Technicals or Fundamentals?

Boris Schlossberg

If you are a diehard fundamentalist like I once was, than this recent piece by Morgan Housel from Motley Fool really makes you think twice. In a column published this week Mr. Housel noted a few inconvenient facts about investing.

“1. Coca-Cola is fighting 12 consecutive years of soda consumption decline. Its stock is at an all-time high.
2. Tesla is changing the world, and orders for its new car are off the charts. Its stock is lower than it was 18 months ago.
3. Cigarette consumption has dropped 44% since 1981. Altria stock is up 71,000% since 1981.
4. WalMart net income has tripled since 2000. Its stock has lost 1.5% since 2000.
5. Apple has earned almost a quarter trillion dollars of profit since 2012. Its stock has barely budged.
6. Amazon’s profits round to zero since 2012. Its stock has tripled.
7. 2009 was one of the worst years for the economy in a century. The market rose 27%.
8. 2015 was a good year for the economy. The market rose 1%.
9. Brazil’s economy is a disaster. Its stock market is flat over the last two years.”

To which I can add my own little tidbit.

The US economy is leading G-3 in growth, rates and monetary bias and yet the US dollar is down more than 1200 pips against the yen and 800 pips against the euro this year.

So much for the forecasting power of fundamentals.

But technicals are of course no better. How many failed Head and Shoulders, how many failed moving average breakouts, how many busted Fibonacci retrace patterns have you seen in your life? And if Elliot Wave was so great, name me one, just one money manager that runs a $1 billion dollar book using that technical philosophy alone. I will wait another hundred years and you still won’t be able to provide me with an example.

Technicals are just a shade better than astrology in their ability to predict anything with accuracy.

The reason both disciplines fail so miserably is that context is everything. Investing is not logical – it’s psychological and once you understand that you can make much more intelligent decisions.

While in and of themselves fundamentals and technicals are often worse than worthless, taken together they can become trading magic because they can provide that most elusive and valuable property of the markets – context.

The classic good trade is often described as one where technicals and fundamentals confirm each other – and that is indeed a good set up. But such combinations are rare, precisely because markets are forward discounting mechanisms and reasons for the rally or the selloff are rarely evident at the time of occurrence

Instead my favorite setup is when the fundamentals go one way and technicals do not confirm the move. This week’s action in USD/JPY is a prime example. The data from US Retails Sales was horrid and the change of posture to dovishness from Lockhart one of Fed’s most hawkish stalwarts should have been good for 100 point sell off in the pair. But the pair did not budge, instead it rallied in face of all this negative news. When price action runs counter to the prevailing narrative – pay attention. That is often a great signal for a move against the consensus view. That is when you often get the best possible glimpse of “context” in action.

So next time someone tells you that they only trade on techincals or that they have never looked at chart in their life – run the other way from those people – because those type of traders have basically completely misunderstood the game that they are trying to play.

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