Market Fundamentals: Use them to Avoid that "Naked Feeling"

I get a lot of questions from less-experienced traders regarding how to best learn about and study "fundamentals" in markets. There is no quick and easy way to study market fundamentals, and I don't know of any books that focus only on fundamentals that impact all the futures markets. The reason books on fundamental analysis of futures markets are so rare is because the subject matter is so enormous.

Here is just a smattering of macro fundamental factors that impact commodity and financial futures prices: weather, world politics, consumer tastes and consumer demand, physical supplies of a commodity, inflation, interest rates, currency values, and natural disasters.

I have been fortunate in my career in the futures industry. When I was a reporter and editor for FWN, I was forced to learn about the fundamentals impacting all the markets I covered--which included all the U.S. markets and some traded overseas. I had to talk to traders and analysts every day for about a dozen years, regarding the fundamentals that impacted the particular market on which I was reporting. Indeed, very few get that kind of unique opportunity to learn about market fundamentals.

An important point to keep in mind is that fundamentals are constantly changing in markets. So, for example, what you read in the Wall Street Journal or a magazine, regarding market fundamentals, can be outdated by next week--or sooner.

Many traders feel almost "naked" when they attempt to trade a market for which they know little about the fundamentals that impact it. Yet, I've said before that learning and keeping up with the fundamentals in a market (or several markets) would be a full-time job (or more). Given that the majority of speculative futures traders have full-time "day" jobs, and trading is either a hobby or "second" job, what's a trader to do?

First of all, the study of technical analysis addresses part of the dilemma of keeping up with all the fundamental factors impacting futures market prices. Remember that futures market price activity and price history, including volume, is a composite reflection of every news event and/or other fundamental factor known to all traders. Price activity also factors in ideas and speculation about the future prospects, and future news, for the market.

Still, to avoid that "naked" feeling when entering a trade, below are some useful suggestions regarding studying and learning about basic market fundamentals:

You should know in what increments your market trades (ticks), the contract size, if it's physically deliverable, cash-settled or both, and when first-notice day and last trading day occur. This information is all free and available on the websites of the exchanges on which the markets trade. For example, if you trade U.S. T-bonds, you should know that prices trade in 32nds of a point, based on a yield of 6%. You don't have to become an expert on yields, deliveries or notices, but you should be aware of the concepts. Reading about what the exchanges have to say about their markets is a great way to start out learning fundamentals.

The Internet is a wonderful tool to help you learn about futures market fundamentals--for free. Use your favorite search engine and do a search on your market of interest. However, make sure you use "futures" in the search words, as this will narrow the focus of the search engine.

Here's a caveat on market fundamentals: The professional traders anticipate them and many times factor the fundamentals into price even before they occur. In fact, this happens quite often in futures markets. For example, it stands to reason that heating oil demand will increase in late fall and winter, and that heating oil futures prices should rise in that timeframe, as opposed to summertime prices. A novice trader may think it's a no-brainer to go long the December heating oil contract in September. However, keep in mind all the professional traders and commercial traders know this, and they have likely already factored this seasonal fundamental into the price of the December heating oil contract.

There are U.S. government economic reports that sometimes have a significant impact on markets. Associations also release reports that impact futures markets. Even private analysts' estimates can move markets. Try to learn about the reports or estimates that have the potential to impact the market you wish to trade. You should make it a priority to know, in advance, the release of any scheduled report or forecast that has the potential to move your market. For example, if you are thinking about establishing a position in the T-Bond market and the U.S. employment report is due out the next day, you may want to wait until that report is released before entering your position. The employment report can whipsaw the bond market in the minutes after it's released, which could stop you out of your position.

If you like to trade financial futures markets, newspapers like the Wall Street Journal and Investors Business Daily have sections that follow bonds, stock indexes and currencies, etc. Reading about how fundamental events impact these markets allows you to get up to speed on fundamentals.

If you trade commodities like cotton, coffee or cocoa, it's a little more difficult to find fundamental news sources for free. You may want to subscribe to a news service like OsterDowJones, where specialized reporters scour the world for news that impacts those markets. The U.S. Department of Agriculture has a website (www.usda.gov) with reports on many commodities that trade in futures markets, including not only the major U.S. row crops, but also markets like coffee and orange juice.

Finally, traders should consider the knowledge of market fundamentals as just one more tool in their trading toolbox. The more tools in a trader's toolbox, the higher the odds he or she will be a successful trader.

Jim Wyckoff
TradingEducation.com