I'm pretty sure everyone here uses, in some capicity, fundamentals to trade. But what we also have an issue with is always using the fundamentals when we really shouldn't, because they don't make sense! Zachary Scheidt, from ZachStocks.com, has come to show us a little about when the fundamentals don't make sense.
He'll be responding to comments and would like to hear a horror story!
There are times in just about every job where things just don’t line up in a logical manner. Equity markets have their own way of turning fundamental arguments upside down and confounding even the most studious trader. There are times when bad economic news turns out to be good news for markets (usually because it leads to easing regulations) or when positive news is met by selling.
At ZachStocks.com, we attempt to find logic in the prices and patterns of growth stocks, and offer trading ideas from both the long and the short side. The blog covers many of the fundamental factors which drive these stocks higher and lower, but sometimes this fundamental analysis just doesn’t cut it. Markets trade as much on investor psychology as they do on cold hard facts.
Back in early March, ZachStocks noted how Citigroup had the potential to ignite a sharp rally based on short sellers covering positions. Citigroup found its strength based on a statement by management which could largely be considered nonsense. The CEO came out and stated that this was turning out to be a “good year” for the bank… this despite the fact that investors had lost 70% of their investment and the bank had been forced to take billions in stimulus dollars in order to stay in business.
Below is a chart of the S&P at the time the Citigroup article was written:
At this point the fundamentals just give us much information to trade with. But the technical metrics actually provided some great insight. Here are the key points that led to our bullish call:
• Short interest is high – Short sellers had been adding to positions as the expectations were for a complete financial collapse. Profits had created an extra bold (and leveraged) base of short sellers who were primed to be hurt quickly by any market strength
• Oversold Position – The market was oversold from both a long and a short-term perspective. From a logical perspective, this leads us to believe that every trader who might want to sell has already sold. There could be little additional information which would lead a trader to finally throw up his hands and bail out. That information had already hit the market
• Rallying off Bad News – Positive news from a discredited Wall Street CEO could hardly be considered good news. In fact, the statement actually drew attention and rage that a manager would make such an arrogant statement during a horrible financial crisis. The fact that the market rallied off this news was certainly a clue.
• Volume speaks… well Volumes! – Pardon the pun but it really is true. On March 10, the market traded sharply higher and the volume (or number of shares traded) was significantly above average. This told us that big, smart (using the term loosely) investors were putting billions of dollars to work. When trading, you want to make sure you are on the same side as the gorillas as they push and bully the market up or down.
In the days and weeks following Citigroup’s announcement, we laid out some attractive long ideas which worked quite well. ZachStocks trades included LDK Solar (which rallied 113% since the article was posted), Clearwire Corporation (current gains of 31%), Netease.com Inc. (current gains of 29%) not to mention Blackstone Group which was discussed just before the rally ignited and has shown gains of 116%.
These positions were entered due to an analysis of the fundamental situation for each company. But the trading gains would not have been possible without an accurate technical view of the overall market. Speaking of the overall market, here is a picture of the S&P just two months after our technical buy signal:
So when investing it is paramount to understand the fundamentals of what you are buying. Fundamental analysis will keep you in the right names that have the best chance of offering above average gains (from both a long and a short approach). But in order to understand when to trade these opportunities, a trading approach must make use of proper technical signals which lead to healthy profits with much less risk.
In an age of turbulence and uncertainty, risk management is paramount and can make the difference between rags and riches. Always have proper loss controls in place and understand the vehicles you are investing in. If you are looking for trading ideas please pay us a visit at ZachStocks.com.