Here is the seventh and final part of our 7 part series titled “The 7 Deadly Financial Spread Betting Mistakes”. Today we will discuss the seventh financial spread betting mistake that financial traders make:
Mistake #7 Listening to the news and fundamental analysis
Essentially there are two main trading styles, one is fundamental trading and the other is technical trading. Unless you are a full time trader and can devote your life to studying the markets constantly, fundamental analysis is not the way to go. Unless you are George Soros who has a lifetime of experience behind him and an excellent understanding of fundamentals you will almost certainly be a losing trader by trading fundamentals.
Even full time traders and fund managers who devote their lives to analysing the fundamental aspects of the markets and hire a large staff to do research for them still get it wrong most of the time. That’s one of the reasons why most fund returns are so poor.
The reason why fundamental analysis is so ineffective and very few traders can make money from this approach is that there are so many variables. For example, when you hear a particular news item or hear very good results from a certain company, many times the price will go down. This is puzzling to most people but the reason is that the markets are always looking ahead and have already discounted the news in most cases.
Another problem with fundamental analysis is that it is also difficult to know what reports or news items are actually true, and even if you know what is true how can you be sure that your interpretation of the news is correct? What about timing? Even if you have good reliable knowledge and a true interpretation of the news, how do you know when to act on it?
Perhaps the most damaging aspect of fundamental analysis is that it does not afford any risk control. If you think a certain market is going to go up but instead it starts to go down, as the price moves further away from your idea, or the point at which you though it was a buy, it must be an even better buy. The market then drops further and looks like a better buy still and so it goes on. Before you know it you have a very large losing position on your hands.
Essentially, if you use the fundamental trading style and are convinced of your research, the more a trade goes against you the better it looks so you end up buying more and getting into real trouble.
You hear about cases like this all the time, and often hear comments from fund managers like “We were convinced of our analysis and that the market was a buy. We bought it all the way down”.If you had been trading correctly, you would just get out of the trade whilst your loss was small. If you are holding a losing trade after 2-3 weeks you are clearly wrong and should be looking to exit the trade.
I have found in my own trading that even if you are not trading on fundamentals but are using a technical trading approach you can be negatively influenced by the news without wanting to be. For this reason I believe that many people are better off avoiding the news altogether.
For example, let’s say that your trading system has generated a buy signal on a particular market but you have heard a rumour or news item that may affect the market you want to buy, you decide it is prudent to hold off from taking the signal and wait. It turns out that the market ended up going up exactly as your system had indicated, but you missed the move through doubting your system.
Now you are reluctant to take the trade as it has moved from where you wanted to buy it and decide to wait until the market comes back to the price that you were originally going to buy at. The market never comes back to that level and becomes one of the great trades of the year. You missed it all because of some news item. Had you not followed the news you would not have overruled your trading system and would now be sitting on a profitable trade.
Of course this could work the other way around and keep you from taking a losing trade. The fact is that it is important to have a trading system and to follow it consistently, regardless of what items you hear in the news or read in the papers. Your profits at the end of the year will come from following your system consistently throughout the year and not from listening to news items.
There is however a positive use for the news which can be useful some of the time and that is using news as a contra indicator. For example, if good news comes out on a particular market and that market goes down then you may want to think about liquidating a long trade or if you are out of a market possibly going short.
Another use for news items is magazine front covers. These are often excellent contra indicators and can be very useful for picking market turning points and can be used to fade (go opposite) to the news. For example, say that we get a headline on a major magazine that runs something like “Cheap oil forever”, that’s likely to be a sign that the oil markets are either at the bottom or near the bottom of the market.
How can this be? Essentially there are 3 types of market participants:
- The investor. Always in early and happy to wait for returns on their investments
- The trader. Never in or out first but catches the meat of the move in the middle
- The public. Nearly always wrong and last in on major moves and also last out.
The cycle tends to go from investor buying at the lows but selling a bit before the top to the public. The public gets in usually at or near the top of the market. Because the investor and the trader are already in the market, the public has nobody to sell to and so as there are no more buyers, the price falls.
When a market reaches the stage of hitting the front covers we are usually at the stage where all of the public are in the market already, so this is a good indicator that the market may be due to reverse. To continue our cycle, the trader usually gives back some profits and sells on the way down. The trader when convinced the market is now in a downtrend sells the market short and profits from the down move.
The public hold on right to the bottom and when they can’t stand it anymore they then sell back at the bottom to the investor and so the cycle begins again. This is another reason why such a high percentage of people lose money (especially the public) in the stock markets. The solution is to identify and follow trends.
A good trading system such as the LS Trader financial spread betting system will automatically get you in to the market when the conditions are optimal. It will also get you out of the market if things are not going for you with a minimal loss. You do not need to know the reasons why a market is moving up (or down) only that it is and then jump on board. This is the way to make consistent profits trading the financial markets.
I hope you have enjoyed reading this 7 part series that I call “The 7 deadly financial spread betting mistakes”.
Good luck in your trading