Technical Trading and Fundamentals

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Hello, Friends. In my neck of the woods, it’s Sunday evening, a good time to review trades from the previous week and prepare for the week ahead. Almost all of my trades are taken on the basis of technicals, but a lot of my initial ideas come from reading about fundamentals. That’s the result of years of practice and repetition. I spent the bulk of my career as a foreign exchange trader and salesman for several large banks, covering large institutional investors. Because currency exposure is generally much more important to fixed income managers than to those handling equity portfolios, my largest accounts were, for the most part, bond shops, and the people I spoke to every day were the individuals responsible for handling international bond funds, and the traders who worked for them.

These clients and their firms remain significant players in the FX market, along with sovereign wealth funds and central banks. Few of these entities pay much if any attention to charts or to technical indicators. Hedge funds and their commodity trading advisor cousins, another important group, cover the gamut in terms of style. Some of these outfits do use technicals in placing and managing trades, often through trading rules that are executed automatically when triggered, with profit targets and stops preprogrammed.The largest players in the hedge fund space, however, the so-called “macro funds”, typically follow an investment process more akin to that of the bond managers.

So, what do bond managers look at? First and foremost, of course, interest rates, including both the yield curves of individual nations and the differentials between them. Since currencies tend to be highly sensitive to changes in interest rate expectations, this component of the total return of an international bond portfolio tends to be managed in much the same way. Bond managers are always looking to buy bonds that are cheap and sell those that are expensive based on their economic forecasts for countries and the projected impact on specific bond maturities. They recognize, of course,  that buying bonds offering a yield that’s 1 percent higher than, say, Treasuries isn’t much of a bargain if the local currency declines by 2 percent versus the Dollar during the holding period. Profiting from both movements in bonds and currencies often seems like an exercise in squaring the circle. Bonds tend to lose value if interest rates are expected to move higher, which is one of the factors most likely to result in a stronger currency.

The interests and concerns of these portfolio managers dictate the sort of coverage that they receive from their salespeople. A large institution will typically have an FX panel of 8-12 banks, with the bulk of the available business going to the top 3 in the queue. Position in the pecking order is partially based on the overall relationship with the bank, which isn’t something over which a salesperson has much control. Where people such as my former self can “add value” (as the jargon has it) is by alerting traders on the fund’s trading desk, or the portfolio managers themselves, to news that might impact their holdings. If, for example, an account is very overweight in Canadian bonds relative to its benchmark, any news affecting Canadian interest rates or the Canadian Dollar is likely to be important. That of course includes flows from other customers that come across the desk. The first salesperson to pass along the information receives a point (some client firms keep score more formally than others), and if first place is achieved consistently, the bank that is represented will likely begin to see more business. That in turn is the sort of thing that will make a sales manager happy, or at least less unhappy.

So what does all of this have to do with what we learn from Todd and Doc at TradingConcepts? Let’s take a look at Friday’s e-mini chart, above. Even if you were on vacation on Friday, as were many institutional managers, you’ll note that the first hour was gently flat to higher. Not a big deal, just another generally positive day, albeit a monthly option expiry. Shortly thereafter, an extended downside vertical bar, somewhat surprisingly (at least to me), appeared at 10:40. This took the price action down to the 61.8% retracement of the day’s range to that point; the next bar pushed through it. The following bar took out the session low. Five points in three minutes, with a trend reversal; not bad, and since I had no position on at the time, I was more curious than upset. Please note that on the chart above I have the session’s initial Fib levels in place. had I had been long, I would have been stopped out at the latest on the break of the 61.8% retracement level.

Still, it was obvious that something had changed, and I went looking to see what was receiving the credit, or blame. On the notifications page on my iPhone, I have headlines coming in from Bloomberg, Reuters, and MarketWatch. I find that Bloomberg tends to be quickest, but Reuters is sometimes more accurate, and provides more color on stories. Still, quickest counts, and on this occasion, Bloomberg reported that Ukrainian forces were firing at a Russian convoy en route to the border with a cargo of “humanitarian aid” for pro-Russian forces. This is where fundamentals come into play. At any point in time, there are typically two, or at the most three, fundamental inputs that institutions are watching carefully. At the moment, I would say that these are potential changes in central bank policy, the Ukraine, and the possibility of more widespread conflict in the Middle East.

Since the headline referenced one of the current Big Three factors, the news seemed likely to be a game changer for the session. I got short, albeit more slowly than probably should have been the case, and got short twice more on retracements, which added up to a pretty good day, and week. Todd teaches techniques that enable us to participate in strong trending moves, but I’m usually reluctant to get involved in volatile markets unless I believe that I understand what is driving them. In this case, I was comfortable using Todd’s tactics, as I was ready to cover a short position on any hint that the initial reports of an enlarged conflict were being denied, or that they had been exaggerated. Of course, it isn’t always easy to tell (as was true in this instance) what’s going on, so it’s important not to delay if a profitable move suddenly reverses. That’s another area in which Todd has a lot to offer, as trailing stops can help to preserve profits even in “V” shaped moves. Parenthetically, it’s often easy to tell if an alert concerning the Middle East is going to impact the E-minis; go to /CL, and see if crude oil is moving. If that contract is quiet, chances are that whatever is going on won’t be influencing equity futures, either.

For what it’s worth, and for those who are interested, most institutional traders and the salespeople who cover them glance over the front page of the Wall Street Journal and the Financial Times every morning, as well as the business section of the New York Times. Those who have Bloomberg Professional terminals of course keep a close eye on those throughout the day; for the rest of us, there are the and websites. As noted, I also scan MarketWatch, which is part of the Dow Jones empire. Reuters puts out a newletter called “The Day Ahead” that is worth subscribing to, and the price is right (it’s free). It comes out in the evening, and highlights potentially important events in the day ahead. I had forgotten, for example, that the Fed’s Jackson Hole conference is scheduled for this week (on Aug 21-23). Fed Chair Yellen will deliver the keynote on Friday morning, and participants in the fixed income and currency markets will be watching carefully. Also closely observed will be European Central Bank President Mario Draghi, who will deliver a luncheon address, also on Friday. If you have to work on a weekend, I suppose that it might as well be at Jackson Hole. Invitations to this annual gathering are coveted, and separate the players in the economics and policy making realms from the wannabes.

There are plenty of on-line news aggregators out there, but by definition they’re unlikely to get the macro headlines out first. For those who use ThinkorSwim, there is an additional resource in the form of the “Market Cast” chat room, which offers expert commentary from the S&P pit in Chicago. Just go to “Support/Chat” from the main page, select “Chat Rooms” and then “Market Cast”. From the right side of the page, click on “Watch” and you’ll get four updated futures charts and, more importantly, the well-informed voice of Ben Lichtenstein of For those who have a ToS account, it’s certainly worth checking out, as the broadcast does an excellent job of pointing out when locals are just playing catch with each other for a couple of ticks, and when “paper”, customer orders, is making an impact.

Just some thoughts for a Sunday evening. The most critical form of preparation, of course,  is to have a good grasp of the principles of trading. Going through any of the TradingConcepts Inc. courses, and following Todd’s or Doc’s webcasts, are great ways to acquire and develop the necessary skills. We’re trading against institutions, however, and although we have some important advantages (we have no benchmarks to constrain us, and we can act quickly when conditions dictate, instead of scaling in or out of a large position), it’s still important, it seems to me, to have an understanding of what they look at, and how they are likely to react to news or other changes in fundamentals. It’s their activity that creates the patterns that we follow in the charts, so knowing a bit about how they work can put us a step ahead.

As always, best of luck tomorrow, and in the week ahead!