Economics and FA – a Recap

It’s a sad yet not so puzzling fact that many traders, retail currency traders in particular, rely purely on technical analysis, believing that fundamental analysis has little to offer. At the end of this post, I’ll talk about why it’s sad. The reason it’s not puzzling though is that unlike levels on a price chart, things like global events and economic news are hard to quantify. It’s difficult to translate such information into an actual trading plan. Thus, many traders never try. Others try and die.

Ahem, right. Pardon the Dune movie reference there. Well ok, so they don’t actually die. They probably blow up an account or something.

Anyway, while I’m a big fan of technical indicators that are supported by rigorous research, I’ve been dedicating a recent series of posts to dispelling this notion that fundamental analysis has limited, if any, utility to a currency trader. So let’s recap some points from those last few posts.

To help us think about how to effectively use fundamental information, I described a framework consisting of three concentric circles. The inner circle is the world of the financial markets, with which we are primarily concerned as traders. Outside that is the economic sphere, which has a direct daily influence on what happens in the markets. Finally, we have the real world of people, things, conflicts, goals, desires, natural forces, and so on, represented by the outermost circle.

In general, the flow of causality is from the outside in. Real world factors affect what happens in the economy and ultimately the markets. So it doesn’t make a lot of sense to ask if a given price movement, in the oil market for instance, is good or bad for the economy. Such questions ignore the direction of the great river of causality. What we should be asking as traders is how developments in the economy will affect the markets, and how events in the real world will affect the economy.

Let’s look at that middle circle. While “the economy” is a useful concept, it’s not a real entity. It’s just a description of the process by which humans apply labor to the environment to get things we value. To figure out whether an economic proposal makes sense, try asking yourself if it would work on Gilligan’s Island. Sometimes this kind of common sense analysis alone can tell you whether a country’s economy (and consequently its currency) is on the right track or headed over a cliff.

Often though, we want to get a more concrete picture of what an economy is doing. This is where economic news releases, which come out every day, come in handy. These are very conducive to objective quantitative analysis, and I’m in the (far too long) process of writing an ebook on just this topic.

Moving outwards to that last circle, we arrive at a place where the analysis is a lot more subjective, but where the rewards for getting it right are much more lucrative. This is the level at which we’re trying to figure out what makes people tick, how they’re likely to behave, and how this will affect the economy and the markets. If we can do this successfully, we may be able to anticipate events before they enter the news cycle, and position ourselves accordingly.

In my post about a possible explanation behind recent moves at the Fed, I pointed to one example of this kind of messy human analysis. In that post I made the point that while people may behave unreasonably, we can still reason about their behavior.

This is also the level at which, at least for me, trading in general and forex trading in particular becomes more than just a job; it becomes cool and fascinating. Many people are news junkies who watch events unfolding in the Middle East for instance with great interest, but if someone asks them what use they have for the information, they often have no answer. Me? I’ve got a position in Turkish Lira and Japanese Yen dammit! It’s my freakin’ job to know which side Erdogan’s on or what the Chinese might do next in the East China Sea.

The fact that there are so many currency traders out there just looking at lines on a chart instead of at the tapestry of world history that’s unfolding in front of them (and which is creating those lines) is what’s sad. They’re missing out on all the fun!

So hopefully this recap will help put some of my recent posts into a larger context. In the next few posts, with which I’ll wrap up this series, I’ll discuss some specific current world events and issues, analyzing how they tie back into the economy and markets.

Specifically I’m planning to cover the these topics:

  • The growing global proxy war and what it could mean for oil.
  • How statist ideology undercuts Fed policy and dooms NIRP to failure in Japan and Europe.
  • Why I don’t trade the Yuan

So stay tuned for those and…keep pipping up!

 

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