How Technical Traders Benefit From Fundamentals
Ramsey trades the highly liquid futures and foreign exchange (FX) markets. Although the majority of Commodity Trading Advisers (CTAs) use a systematic approach, Ramsey is strictly a discretionary trader.
He also differs from most CTAs by incorporating fundamentals into his decision making process. Ramsey begins by establishing a broad fundamental macro view that determines his directional bias in each market. Once this bias is established, he will seek to go short the weakest market in a sector if he is bearish or long the strongest market if he is bullish, using technical analysis to time trade entry and position adjustments. Ramsey will score his best returns when he gets the fundamentals right, but even when he is wrong, his rigorous risk control keeps losses relatively small. This is very similar to how Logikfx members approach the Forex market, following the footsteps of many successful hedge fund managers to create profitable portfolios.
An important lesson Ramsey provides is that even technically oriented traders as Ramsey himself was in the early years of his career can benefit greatly by incorporating a fundamental perspective. It is not a matter of performing any complex fundamental analysis to derive price projections, but rather a question of trying to understand the key fundamental drivers that are likely to determine the direction of the market. For example, by understanding that fundamentals were as negative as they could be for bonds at the start of 2000, Ramsey correctly assumed that bonds had very limited scope on the downside and that any weakening in the strong economy or the prevailing speculative fervor could set in motion a major bull market.
As another example, Ramsey expected the end of QE2 to lead to a reversal from dollar weakness to dollar strength. Once he has established a firm fundamental opinion, Ramsey utilizes technical analysis to confirm his anticipated scenario. Combining his technical methodology for entering and exiting trades with a strong fundamental directional bias provides Ramsey with a more effective trading approach than would be possible using technical analysis alone. The idea is to identify the big picture fundamental factors that are likely to drive the market in one direction and then to use technical analysis to trade in that direction. Fundamentals can also be useful as a contrarian indicator. Ramsey will look for situations where there appears to be a predominant market perception that is being contradicted by the market action. Ramsey cites the example of a bond market where there was a lot of concern about government borrowing crowding out private borrowing, but interest rates failed to rise. In this context, a bearish fundamental factor had bullish price implications because of its failure to impact prices. Ramsey will always buy the strongest market in a sector for long positions and sell the weakest market in a sector for short positions.
Many novice traders make the error of doing the exact opposite. They will buy the laggards in a sector on the typically mistaken assumption that those markets haven’t yet made their move and therefore provide more potential and less risk. When Ramsey is looking for a reversal in a sector, he will focus on establishing a position in the market that lagged most on the prior price move. For example, when Ramsey anticipated the dollar would reverse to the upside at the end of QE2, he sought to sell currencies, such as the Turkish lira, that had been weak despite the prior dollar weakness. Ramsey pays a lot of attention to price movements in related markets.
The failure of a market to respond as expected to a price move in a correlated market can reveal inherent strength or weakness. For example, after years of moving together, in early September 2011, equity prices rallied, but commodity prices weakened. Ramsey read the failure of commodity prices to respond to equity market strength as a signal of impending weakness. During the second half of September, commodity prices and commodity currencies (e.g., Australian, New Zealand, and Canadian dollars) plunged. Perhaps the hallmark of Ramsey’s trading approach is his rigorous control of risk. Ramsey will typically risk a mere 0.1 percent on each trade from point of entry. Once he is ahead on a trade, he will allow for more risk latitude. This approach all but assures that losses on new trades are likely to be quite moderate. The only time Ramsey is vulnerable to a significant monthly loss is when there are large open profits from winning trades. Although the use of a 0.1 percent stop point from entry is probably too extreme (or perhaps even inadvisable) for most traders to adopt, the general concept of using a relatively close stop on new trades and allowing a wider stop after a profit margin has been created is an effective risk management approach that could work well for many traders.
Success in trading requires dedication. Ramsey continues to trade and monitor his positions even when he is on vacation. He also awakens himself multiple times each night to check on his positions. This type of all-encompassing commitment to trading it is not necessarily recommended as a lifestyle, but rather is offered as an observation of one of the characteristics of trading success. For Ramsey, however, I suspect such commitment is not a burden, as trading is a passion, not a chore. Chapter 4 from Hedge Fund Market Wizards discusses Scott Ramsey's story in detail. This is just a short snippet of this section showing how a Technical Trader can benefit from using fundamentals.