Futures: Fundamental Analysis
by Jack D. Schwager

Nov 2001

Ed. note: Trading and investing are two different things; the business of investing is, obviously, more fundamentals-oriented than trading. This review, at the time it was written, spoke to the trading side of things only.

Caveat emptor

There is no question that, when it comes to informational books on the futures markets, Schwager is one of the best around. This book meets his high standard of quality and informativeness. I can recommend this book to anyone looking to broaden their knowledge of fundamental analysis and the guts of what affects supply and demand. But I can't recommend the book wholeheartedly, because basing trading decisions on fundamental analysis in itself is such a flawed approach in my opinion.

I used to pay a lot of attention to fundamentals (as a commodity broker). I would spend hours each day looking at news and research to get a feel for the reasoning behind the movement. After doing this for a while, I realized the inherent futility in the approach—if a trade sets up technically I will take it, unless there is some compelling reason not to—and if there is no technical confirmation, I won't take it, period. So fundamental analysis just doesn't play a starring role in either case. Nowadays, I still keep tabs on fundamentals, but mainly to avoid getting hit by a train; not taking action in front of a significant report, going short coffee in the freeze season, stuff like that. Below are a few reasons why my trading has taken on a strongly technical flavor:

1) Most daily news is worthless, and here is why: at any given time, there seem to be half a dozen arguments for being bearish on a market, and half a dozen arguments for being bullish.

When a market has a big move up and the reason isn't clear, the news services pick a couple of the bullish reasons and talk about those. If the market has a move down, they highlight some of the bearish reasons. It's total retrofitting, and thus usually a waste of time (in that there's not much of a way to turn that knowledge into profit).

Furthermore, the "traders" that the newsies interview are often just run of the mill clerks or brokers who don't really know anything special… or if they do know, they aren't telling. The classic filler explanations on the aftermarket newswires center around buzz phrases like "profit taking," "fund buying" and "fund selling." When you read about one of those three, the general translation is that the reporter dragged out an old standby because "who the heck knows" just doesn't make good copy.

2) Many of the best trades are the ones where the move starts before anyone knows why. Bruce Kovner talked about this concept in the first Market Wizards. If a breakout occurs when everyone is expecting it, then everyone is already in, and the odds are not as good because a lot of the buying (or selling) is already done. But if a breakout occurs and no one knows why, then there are 1) potentially powerful hidden reasons for the move, and (2) a whole group of traders who are not in the market yet, and may want or need to get in (or out if the move is against them) once the reason comes to light.

So, by deduction, if some of the best trades are the ones where fundamental reasons are not yet clear, then by paying attention to fundamentals too much, you run the risk of keeping yourself out of the best trades. You have to be willing to sometimes say, "I don't know why this setup is occurring, but the technicals are tellling me something interesting that the news might confirm later." Because the confirmation of "why" often comes after the window of opportunity has closed, you have to be willing to act before the fundamental reasons are clear.

3) Analysts are often biased and have a hesitancy to change views. When an analyst writes down his opinion on a piece of paper and then sends it out for everyone to see, part of his (or her) pride and reputation is staked on that opinion. It is a psychological truth that writing something down, and confirming it to other people, makes a person more committed to that belief. (Humans have a very strong desire to be consistent.) That make the typical analyst very hesitant to change his mind, even when the facts change. If an analyst is bullish one week and then the facts turn bearish the next week, the analyst should change his mind—but the odds are that he will not, because he will be thinking "well, if I was bullish last week and do a 180 to bearish this week, then I will look stupid."

But often that is the right thing to do! Especially for fundamental analysis, being flexible is very important. But most analysts are too worried about their reputations to have that flexibility. This is one reason trends unfold over time—because the masses are hesitant to change their minds quickly, even as it becomes more and more clear that they should.

4) Much of fundamental analysis is either incomplete or just plain wrong. Even if you have 90% of the puzzle pieces, the 10% that you are missing could be important enough to turn the whole picture upside down. Or if you somehow miraculously have all the pieces, you still have to figure out how to weight them properly and determine what the market is going to pay the most attention to. It is almost impossible to get all the facts correctly uncovered and assembled without overlooking anything.

And then there is always the possibility that something could come up by surprise that you were not prepared for. Different analysts with access to the same information will often have directly contradicting opinions on a market. What does that tell you? Generally the only time that the analysts are all on the same page is when the writing on the wall is obvious… and by that time, the move is usually almost done if not over. There is simply no free lunch.

5) Price—the ultimate value judgment of all underlying fundamentals—reveals itself in the technicals. The technicals don't lie (though they can certainly deceive), and they don't harbor an emotional bias. They represent the opinions of the entire market, with a heavier weighting towards the bigger and smarter players, and are thus more reliable than individual opinions subject to bias and error. For a fast mover such as myself, this is what needs to be known. As far as trading goes, I'm typically interested in the next three days or weeks… not the next three months or years.

For the above reasons, fundamental traders caveat emptor.