Fundamental Analysis

[hausse]

Large price moves spanning many months and sometimes years with substantial percentage increases or declines in price happen for fundamental reasons. The causes of such trends interest me and I wonder how one can become knowledgeable about the fundamental situation in a given market.

I read Jim Rogers' Hot Commodities book and he explains the fundamental situation of commodities in general and of several markets specifically. That was most interesting.

However, I do not know where to find the relevant information and to determine what information is relevant in the first place. For example, in the energy complex I read occasionally that no new refineries were built during the last 20 or so years or that no substantial investment in infrastructure for the transport of natural gas happened in the gulf states in a long time with the result that there is a shortage in the area and some of the states now have to import(!) natural gas for their domestic use.

The above two items (refineries and natural gas in the gulf states) are interesting to read about, good and well. But how can one find out these things by oneself, preferably at an opportune time? Or other important developments in other markets, like metals, grains whatever?

The past (and current) bull moves in commodities may serve as interesting case studies. And while it is nice to catch them mechanically via long-term trend systems it would be even nicer to have a grasp on the fundamental situation before such moves happen or at least at a reasonably early stage and thereby increasing one's probabilities for success with whatever technical approach one uses for entry and exit.

There are some ET members proficient in fundamental or theme based analysis. It would be great if you would shed some light on how you develop a fundamental analysis, decide what information is relevant etc.

 

[Cutten]

The short version is that you spend the next 5 years reading a crapload of reports, analysis, accounts, financial newspaper/magazine/website analysis (from good sources like the Financial Times, Bloomberg etc, not junk like MSN Money or Business Week), trade journals of any industry you want to focus on etc. This will make you pretty knowledgeable on current fundamentals. To take an example, Buffett in his early years would read the annual accounts of every single stock on the NYSE. You will need to learn how to read accounts, balance sheets etc.

You also need a good understanding of economics as it relates to financial markets. If you don't have any economics training, it can take a while to catch up - economics has lots of counter-intuitive concepts and takes a long time to figure out for most people IMO. Either do a course, get a tutor, or read craploads of economics stuff. You should get up to degree standard at least on the general concepts (no need for the more technical stuff - most economics is supply and demand, once you understand that the rest comes along naturally. It can be useful to study banking, interest rates, and money as well, since we operate under a fractional reserve system.)

Lastly, you should read as much financial market history as possible. This will show you what is possible in the markets, under various different conditions.

If you study hard on all those 3 areas, then after say 3-5 years you should start to find that you begin to understand and sometimes even anticipate market moves based on fundamental developments. You may however find yourself often being too early to get in, and too early to get out. It can take a while to realise how to integrate fundamental analysis into actual trading.

When I started, I had literally no knowledge of fundamentals. I had no clue why currency X might appreciate against currency Y. Within about 3 years I was understanding the moves, and eventually anticipating them. However, it took me quite a bit longer to then get a feel for how long the moves could last. I'm still learning that now lol.

 

[hausse]

Thank you for your reply, Cutten.

I am in this for the long run, so studying for years is fine with me. Speculation is permanent study anyway.

What do you mean with "You also need a good understanding of economics as it relates to financial markets."? I know some economics but what do you mean how economics relate to financial markets? Do you see a special way in how they relate?

You mention financial market history. This I find fascinating. Could you kindly recommend sources you found useful?

In my experience, the actual trading part is not too difficult if one doesn't try to be smart. There are a number of technical methods and systems one can use to profit from trends. The Donchian Channel and Dual Moving Average Crossovers for example. Gallacher's "Winner take all" is instructive here. The first edition is better than the 1993 edition, IMO.

A way I personally like to use is to determine the state the market is in by examining factors like volatility, strength of trend, the chart, sentiment. Bull and bear markets have certain behaviours that one can notice with experience. Similar to a doctor performing a diagnosis. I am then willing to exit partially when I see volatility extremes after a large price run up, as an example. Failures are another one.

Many other entry and exit tools can be used. So the trading part doesn't need to be difficult. Not so simple is to determine when to use the tools if one doesn't want to trade a mechanical system all the time. I am exploring fundamental analysis in the hope that it can help in detecting opportunity periods and avoiding long sideways phases which are rather uninspiring when targeting trends. Know what I mean?

So, when you look at a market fundamentally, how do you tackle it and how do you decide what is important and what is not? Would you mind giving an example or two?