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In the past, two schools of thought on trading ruled: fundamental trading and technical trading (or reports vs. patterns/pictures). Today, both of these schools are also greatly affected by a third thought: macro trading. Following are explanations and examples to help you determine which type of trading suits you best.
Fundamental trading was really the first type of a decision-making process that gripped traders, even 100 years ago. Its derivation lies in the equity arena where traders were trying to apply their own common-sense principals into the process of anticipating which stocks were likely to rise and which stocks were to be sold. What is known about the company and its books? What has the board of directors decided to do lately?
When agricultural and mercantile exchanges began to open to help producers in the cyclical money management of their products, a lot of these principles were readily applied.
The traders who subscribe to the fundamental approach will be primarily looking at the number of total planted acres and harvested acres, weather, and export sales. Interest rates and information about seed technology and test weight should be examined as well.
A person could argue that it’s almost impossible to make an investment decision without all the fundamental information, but it happens millions of times a day. The people who make decisions based on pure math, graphs, and charts are the technical traders.
In the “A Technical Look” chart on page 00, there are a multitude of patterns and pictures at work.
The stochastic reference that runs through the bottom of the graph refers to the theory that as prices rise or decrease, the closing prices will also tend to rise or decrease, and the red and blue lines at the bottom are exactly that. This reference graph is a commonly used tool by floor and desk traders.
The volume color bar gives a visual representation of the relative excitement in a product. Generally, this measure is an indicator that a trend is ending. High volumes on the lows might mean that the lows are close to being in. Low volume on the highs might mean that the buyers are exhausted and the highs are in.
The high/low/close portion in black is at the top of the chart. Many books have been written on the formations of patterns, and here is a classic one. The triple-top pattern may indicate to some followers that the move is over to the upside and that it’s been exhausted. Traders also like to draw support and resistance lines on these charts to keep track of trend lines.
Other indicators that may be overlaid onto these charts are 20-, 50-, and 100- day moving averages. Some will even go out as far as 200 days.
The whole point is to illustrate that there are a multitude of technical tools all centered on patterns and pictures. When these things are laid out in this way, traders can get a good feel for the product in a two-dimensional fashion.
These tools are interpretive and have no exact right or wrong answers. There are hundreds, if not thousands, of books written on this subject.
This quite possibly is the most difficult part of a trader’s job. This macro picture is an all-consuming reason/excuse for why a particular commodity moved the way it did on any given day. Certain subjects move into the macro vernacular and then back out on a daily basis.
One good example is the Greek debt crisis. It’s forgotten about until it’s not forgotten about. The U.S. dollar, oil, and sovereign debt are just a few of the recent headliners. The key to getting a handle on these moves really means getting a handle on the industry as a whole.
Fundamental traders will be greatly affected by macro news and events. For instance, if no other nations have money to buy U.S. corn, the price will most likely go down. Our own tight balance sheet issues may be overshadowed by a European nation defaulting on its debt.
Technical traders can be caught off guard when the levels of support and resistance that they really may have pinned their hopes to are breached.
For instance, in the past few years there have been a number of examples of this in the U.S. stock market. At these times, technical traders saw the world throw all of its so-called rules out the window. Who cares about a moving average when the stock market has a panic attack? Who cares about stochastics, Bollinger bands, and RSIs (relative strength indices) when we have an age-old American investment institution going bankrupt with scores of others soon to follow?
And just when you think you have a handle on things, raw technology takes control.
Technology is a macro issue because it is a trading tool without borders. It is a trading tool that has a single language that is not widely spoken but is widely employed. It is a trading tool that has no hours and very few limitations. It is the world’s ultimate leveler.
Traders and institutions use what are called icebergs. These are orders that are programmed to be shown only to the electronic market in small quantities so as not to give away the purchaser or seller’s total size and intensity. The financial world is all abuzz about the high-frequency trading taking place that’s knocking the naughty black box trading machines off the front page for the time being.
Many years ago, the cigar-chomping, seasoned veterans with the green visors used to speak about the voice from the tomb. A quick Internet search reveals this was just a very early, rude and crude technical trading tool that was made possible by crunching years of data in the wheat market for some sort of cyclical pattern.
This technical trading tool can now be replicated for thousands of markets, updated by the second, because of the width and breadth of the technology that is at our fingertips today.
Now, take all the data and without a way of representing that data, all we really have is just a bunch of data. The next big wave in the technical trading revolution will be in the data-mining arena.
There are companies that only mine data from massive databases – relevant data – and make an intelligent trading platform around it. Now throw in the ability of these firms and their computers to update and back-test instantaneously, and you have a pretty powerful tool. The term artificial intelligence is creeping back into the trading room, and it’s saying all over again that you just don’t know what you think you know.
So keep learning and keep changing up your game plan. Figure out what type of trader you are and use all the tools of technology to help you make the best trading decisions for your operation.
Scott Shellady is a fixed income manager for XFA. He is an experienced trader of commodities and financials in North America, Europe, and Asia. Shellady holds a Chicago Mercantile Exchange Group membership.