The Basics Of Analysis And Rational Trading And How It Influences Stock Traders

Provided By Ultimate Trading Systems

How does fundamental analysis affect the average stock traders?

For a number of years, fundamental analysis was considered the only real or proper way for stock traders to make decisions. In the late ‘70s and early ‘80s, technical analysis was used by only a handful of stock traders. As difficult as it is to believe now, it wasn't very long ago when most of the financial experts, major funds, and financial institutions thought that technical analysis was a flawed and nearly useless tool.

Today the opposite is true. Almost all experienced stock trader use some form of technical analysis to help them formulate their stock trading strategies.

Except for some small, isolated pockets in the academic community, the "purely" fundamental analyst is virtually extinct. What caused this dramatic shift in perspective by stock traders?

The answer is simple: money. The problem with making trading decisions from a strictly fundamental perspective is the inherent difficulty of stock traders making money consistently using this approach.

In case you’re not familiar with fundamental analysis in relation to stock traders, here’s a brief explanation. Fundamental analysis attempts to take into consideration all the variables that could affect the relative balance or imbalance between the supply of and the possible demand for any particular stock, commodity, or financial instrument. Using primarily mathematical models that weigh the significance of a variety of factors (interest rates, balance sheets, earnings projections, supply and demand, and numerous others), the analyst projects what the price will be at some point in the future and how it will effect stock traders.

The problem with these models is that they rarely, if ever, factor in other stock traders as a variable. People, expressing their beliefs and expectations about the future, make prices move—not models. The fact that a model makes a logical and reasonable projection based on all the “relevant” variables is worthless if the traders who are responsible for most of the trading volume are not aware of the model… or don't believe in it.

As a matter of fact, many stock traders – especially those on the floors of the exchanges who can move prices dramatically in one direction or the other – usually don't have the slightest concept of the fundamental supply and demand factors that are supposed to affect prices. And, at any given moment, much of their trading activity is prompted by a response to emotional factors that are completely outside the parameters of the fundamental model. In other words, the stock traders who trade (and consequently move prices) don't always act in a rational manner.

Ultimately, the stock trader could find that a prediction about where prices should be at some point in the future is correct. But in the meantime, price movement could be so volatile that it would be very difficult, if not impossible, for a stock trader to stay in a trade long enough to make money.

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