Fallacies of trading fundamentals

  • Aug 08 2022
  • by
  • Analyst AZA
Fallacies of trading fundamentals

Fallacies of trading fundamentals

Trading fundamentals require rules and an understanding of how the news release will impact the underlying markets. In this article, we will be explaining how a trader should interpret fundamentals and some of the popular fallacies associated with trading fundamentals. We will be starting with the most common mistake traders tend to do when trading fundamentals.


Most traders will associate fundamentals that are bearish with a market that is selling or a market that has an excessive supply. Such a conclusion can be possible but can result in undesirable outcomes. For example, assume the dollar index is trading at a $101,00 price level, and the NFP release shows an unexpected 250,000 jobs lost against a 150,000 job loss expectation. Given this situation, the fundamentals can be reasonably interpreted as being bearish for the dollar index. Assume that prices start to move lower. Are the fundamentals still bearish at the $100,00 price level? very likely. At $99,00? probably. At $98,00? $97,00? The point is that at a certain price level the fundamentals are no longer bearish, no matter how large the impact of the NFP was projected to be. It's possible that a bad news release can be positive if prices have overdone the downside. Thus, the bearishness or bullishness of fundamentals is judged following the current price level. The inability of many traders to acknowledge this concept is the reason why fundamentals are perceived to be bullish at marker tops and bearish at market bottoms.


Financial news sources often report outdated information and new data in much the same way. For instance, an article with a 'headline that the UK economy is projected to appreciate by 3%' can easily be perceived as being very bullish for the Pound. However, what the article is not likely to report is that this may be the third or fourth such projection being released. There is a high chance that the previous months also projected the same magnitude of increase. The main point is that most of the data that sounds new is actually outdated and has already been discounted by the market.


The usage of 52-week comparison is used by many traders, probably because it provides a simple means of instant analysis. This strategy is overly simplistic, however, and traders should refrain from using it. For example, a trader can use the performance of the GBP/USD in the previous year to make decisions about a trade in the current year. This can be fatal, because the market environment, sentiment, or market regime can be different from the previous year.


This mistake is done by most traders, especially short-term traders. Fundamental analysis is best suited for constructing yearly, monthly, or quarterly projections. However, it is very irrational to try to boil supply and demand statistics down to the point at which they give an instant signal, which is what some traders do when they rely on fundamentals for timing. It is not surprising that most of the traders who base their trades on such items are unsuccessful. The only major exception is traders who utilise this data in a contrary fashion, such as viewing the failure of a currency to rally after a release of a bullish report as a signal to sell the currency. Traders must also guard against the urge of wanting to take a trade immediately after concluding an analysis that indicates either an overpriced or underpriced market environment but should wait for a good entry level. For purposes of timing, it's advisable to use technical analysis.


Assume the following situation: a news release suggests that home sales have significantly dropped. Does this report suggest a major buying opportunity? wait a second. Do home sales reports have a high impact or low impact on the market? the answer is no. Therefore, the trader needs to ask themselves how important is the news release to the market in terms of the bigger picture.


Markets are often forward-looking and place a greater emphasis on what the participants are expecting to happen for the following year than on prevailing fundamentals. This pattern is especially true in situations where the economic outlook might be in a transition. For example, during the COVID-19 pandemic, most central banks around the world adopted accommodative monetary policies. Even when central banks had implemented expansionary policies, the markets were already expecting the change in the monetary stance. In response, the market started pricing in the monetary tightening before it happened.


Sometimes it can be very difficult to utilise a forecasting model for a market if the historical data acquired is not enough. For instance, a trader cannot construct a quarterly forecast without considering all of the data that is influential to the performance of that particular market. Recently, there have been some recessionary fears in the United States, but there are some factors that are unsupportive of that expectation. The labour market has been robust in the US, this makes the fear of a recession seem kind of immature. According to some analysts, it would make sense to be concerned about recessionary fears when companies start laying off some workers or there is a significant cut in wages, provided all other inputs like inflation and inventories remain the same. Traders need to make sure they include all the necessary inputs into the fundamental forecasting models.


Every fundamental trader needs technical input to be able to have good timing for executing their trades. Understanding fundamentals is key to the success of a trader because they move the market and sometimes the movements can be wild. Short-term traders should always be aware of the data releases that are upcoming so that they can minimise their exposure or protect themselves against potential massive movements in the market. I advised traders to react to the news rather than trying to predict the outcome of the release because that takes the resemblance to gambling. As traders get experience in Trading fundamentals they will start to be good at anticipating potential movements and they will be able to intuitively time the movements. Good luck and God bless.

Financial news sources often report outdated information


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