Technical vs. Fundamental: How Do Traders Differ?
Copyright 2000 Barclay Trading Group, LTD.
Terms, Conditions and Trademarks Apply.
Among the various approaches to trading utilized by leading CTAs, the most basic distinction is between "technical" and "fundamental" analyses of the markets. Fundamental traders generally rely upon an analysis of factors which affect the supply/demand relationship for specific commodities (e.g., government crop reports, interest rates and money supply, geopolitical news). Technical traders, on the other hand, rely upon an analysis of a commodity's prior price movement to predict future trends, believing that a commodity's price already incorporates the effects of knowable fundamental information. In this issue our roundtable features a point/counterpoint discussion regarding the strengths and limitations of technical and fundamental approaches. Our panel of distinguished CTAs includes two fundamental traders, Steve DeCook and Gary Gerstein, and two technical traders, Jerry Parker and Allen Weiss.
Steve DeCook, Fundamental Futures, Inc. Mr. DeCook has traded the agricultural futures markets from a fundamental standpoint for more than 20 years. Today his firm manages approximately $41 million.
Gary Gerstein, Red Oak Commodity Advisors. Mr. Gerstein has been active in the investment management field for 24 years, primarily in the area of fundamental analysis of equities. He founded Red Oak in 1989 and currently manages approximately $50 million.
Jerry Parker, Jr., Chesapeake Capital Corporation. Mr. Parker began his career as a CTA in 1983 under the tutelage of Richard Dennis. In 1988 he formed Chesapeake, which today manages $92 million.
Allen Weiss, AZF Commodity Management, Inc. Mr. Weiss founded AZF in 1984 and utilizes a long-term diversified trend-following system. AZF currently manages $102 million.
Q: What career experiences led you to develop either a fundamental or a technical approach to trading the commodity markets?
DeCook: I grew up on a farm in central Iowa and worked on it every day until I went to Iowa State to get my degree in agricultural economics. I still take an active role in farming my land today. So both my past and my present give me an intrinsic understanding of the agricultural markets I trade. I can sift through the barrage of fundamental information to glean what's important-information I can use to make money in the markets. I don't even own a computer, and the technical aspects of the market don't intrigue me the way fundamentals do.
Gerstein: Before becoming a CTA, I had over 20 years experience as an equity analyst and money manager. I have always used the same approach regardless of the market-I search for situations where the fundamentals as I interpret them are not yet reflected in market price.
Fifty years of empirical evidence convinced me that a rigorous approach based on intrinsic value yields greater than average rates of return in the stock market. I presume the same strategy that served me so well in equities will work in the futures markets. So great is my conviction, I really couldn't trade futures any other way.
Parker: I participated in the Richard Dennis "Turtle Program." The methods we were taught and the trading experience received were all a technical approach to trading the commodity markets. The most important experience that led me to utilize a technical approach was the amount of success that I experienced trading Rich's system.
Weiss: What distinguishes us from other CTAs is the fact that we run our research back as far as we can gain access to charts of the markets. We chart an optimum curve on every commodity going back 150 years using the cash markets. We also take the worst optimum curve and plan on that happening. Then we see what we can come up with that still works.
Today many systems will optimize a curve to the point of not being able to make it work for the next economic situation. That is why most systems that have under a 5-year track record are unpredictable. If you understand how any system will work for different economies, you've got a major advantage on your side.
One should be looking at an investment over the long run-not what it makes in any one year, but how it compounds over 3, 5, and 7 years-just as one would look at a long-range real estate venture.
Q: The number of technical traders has increased much more rapidly in recent years than the number of fundamental traders. What factors account for this phenomenon?
DeCook: As its name implies, technical trading is technology driven. Its growth has been spurred by the fascination with and explosion in technology. The ability to back-test trading systems with the touch of a button is something we wouldn't have dreamed of when I started managing money 20 years ago.
Technical trading is objective; fundamental trading is subjective. It can take years to develop abilities in subjective analysis, while it seems to me that technical expertise can be refined more quickly. Simply put, technical trading is easier.
Gerstein: Remember we are quite new to the managed futures industry, so our perspective is necessarily limited; however, the managed futures industry is also relatively new.
I believe that given the industry's limited history, traders new to management are biased toward a methodology that can be back-tested. Technical systems can be back-tested; fundamental approaches cannot be. I would add that both technological advances per se and an increased number of technologically skilled individuals turning their attention to the markets also have contributed to this phenomenon.
Parker: Technical traders do not need to have a particular expertise in each market that they trade. They do not need to be an authority on meteorological phenomena, geopolitical occurrences or the economic impact of specific worldwide events on a particular market. This allows a trader to manage a more diversified portfolio and experience the accompanying benefits of such an approach.
Technically oriented programs that utilize a few variables can be tested on a computer using historical data and can be analyzed by rigorous statistical concepts. This allows intelligent people utilizing high-tech computers to devise profitable trading systems in a cost efficient way.
Weiss: The growth in technical traders is due to success breeding success. Fundamental traders can get ahead of themselves in the market place. We at AZF are both technical and fundamental. We look at the technical first and then the fundamental.
Q: The amount of money traded according to technical systems has also increased significantly. To what extent has this affected the movement of the major commodity markets?
DeCook: We consider it a significant factor in the movements of our agricultural markets, especially in the short term, and it's a factor we try to exploit. Trend followers piling in on top of each other exaggerate market tops and bottoms.
It used to be that a breakout to the upside on big volume was bullish in the grains, because it indicated heavy commercial or speculative buying. Now it is bearish because it indicates "fund activity". Our floor people even qualify the fund activity by FCM, suggesting that we fade the fund activity at certain houses where they're always perceived to be buying tops and selling bottoms.
Gerstein: It is my belief that many technical approaches have similar theoretical underpinnings. As you point out, in recent years there are more technical traders in the market place. Combining these factors creates the tendency for markets in the short run to be more volatile.
Parker: The commodity markets tend to have more extreme price movements as more money becomes traded by technical traders. Also, the liquidity of the markets has improved as more speculators enter the markets, thus improving the execution of trades made by both speculators and nonspeculators, assuming that a sufficient number of trades takes place at various price levels and times.
Technical systems have become popular over the past few years, but problems are created for everyone when too many systems make trades at the same time and price level. In order to achieve profitable results, future advances in technical trading systems must take into consideration their similarity to systems used by other traders.
Weiss: The money in the industry has grown significantly over the last three years and most of that money was under technical systems. The shorter term a system is, the greater the slippage under both technical and fundamental methods of trading.
Q: Whether you trade technically or fundamentally, the amount and immediacy of information provided to you by means of telecommunications and computerization has increased dramatically. What problems or opportunities has this accelerated data flow created for your trading approach?
DeCook: When I first started trading 20 years ago, I thought I had an informational "edge" on other traders because of my location in central Iowa and my hook-up to the farmland grapevine. With the explosion and immediacy of information today, I have lost some of that informational edge. I have much more information, but so does everyone else. That only makes the subjective "sifting" process more important to success, so maybe my years of experience give me an edge there.
I'm more convinced every year that trading is more an art than a science. The amount of information one has is not proportional to one's success in the markets.
Gerstein: Apart from lengthening our work day, the amount and ready availability of information has had little to no effect on our approach. As I interpret the additional information, it pertains more to short-term market moves. We use a somewhat longer time horizon than many other traders, concentrating our efforts on identifying medium to long-term major market moves.
Parker: CTAs are now able to trade more markets more often with better technical information, and everyone is operating on a more equal playing field. More of the fundamentals are disseminated now than ever before and faster than ever before, which takes away some of the edge that the speculators enjoyed in earlier years. This increase in information has also improved the liquidity of the markets by allowing more people to participate in a cost efficient way.
Weiss: Accelerated data flow has not changed what we are doing whatsoever, since we take a long-term view of the market place.
Q: Technical analysis is based on the assumption that markets are efficient. Fundamental analysis implies market inefficiency. What is your opinion regarding the behavior of the major commodity markets?
DeCook: If I thought markets were efficient, I wouldn't put myself forth as someone who can occasionally beat the markets. Analysts these days have mountains of information, but it's become overwhelming. The market reacts to a piece of news one day, then ignores that same news the next day. Our job as fundamental futures analysts is to correctly anticipate changes in market sentiment and sift out the information which will have a more lasting impact on the markets. The hard part is to do that with consistency.
Gerstein: My partner Phyllis Weaver tells a great story. She was at Goldman Sachs when Fisher Black [Black-Scholes Options Pricing Model] first left MIT to join Goldman. When the press asked him how he was adjusting to the differences between academia and Wall Street, he said, "The markets were much more efficient at MIT." But seriously, with all due respect, I disagree with your premise. Both successful fundamental and technical approaches are based on applications of probability theory. We don't profess to forecast the future correctly all the time, but we are able to assess the probability of a future outcome and whether it is reflected accurately in the markets.
Technical systems are also based on probability distributions. For either approach to have a chance at success, the probabilities must be accurately assessed.
Parker: Profitable trading, technical or fundamental, is dependent upon inefficient markets. Efficient markets prevent any type of system from extracting profits from the markets. Technical trading is successful because it rightfully assumes that some important fundamentals cannot be known until the profit opportunity has passed.
Fundamental analysis that excluded the possibility of an Iraqi invasion of Kuwait in the summer of 1990 would have been incomplete and possibly unprofitable, or worse. This was the only "fundamental" that was worth knowing, yet was the very one that almost no one could have known. Technical analysis relies upon the idea that smart money will move into a market and give advance warning that a position should be taken. This often occurs when the true major fundamentals are unknown or the apparent fundamentals are in conflict with the technical analysis. The fundamentals may accurately indicate an overvalued or undervalued situation in a market. These situations can remain constant for long periods of time, and one can lose money being right on the market but wrong on the timing.
Technicians seem to be more willing to accept a small loss generated by the trading system than fundamental traders. Traders must accept the assumption that the markets reflect the true reality. Our pride and opinions should not interfere with sound trading approaches.
Weiss: The mind is more powerful than any computer. After you hand-chart a market, there are certain predominant patterns on most commodities that will occur over and over again. The market is ultimately based on human psychology. You are really charting human psychology and converting it into mathematics.
Copyright 2000 Barclay Trading Group, LTD.
Terms, Conditions and Trademarks Apply.