Fundamentals for Traders

In The Original Turtle Trading Rules, Curtis Faith described their method for adjusting their position size. The Turtles used a normalizing algorithm based on the dollar volitility of the market. This comes from an in-depth understanding of the market they were trading and this overview of the background market had specific applications to each commodity they traded.

In a series of videos John Jagerson explained the ROE Ratio and how it can be used to discover the base performance of a security. This is meaningful only when compared to other securities in the same industry and relative to the market, sector, or an index. From this traders can get an overall perspective into the the potential volitility of their security. If the ROE Ratio lies at either end of the spectrum of other securities within the same industry or sector, then the volitility could be too high or low for short-term trading. But if it lies somewhere near the middle, the volitility could lead to better profitability.

Of course this volitility creates an interesting insight into options – like covered calls.

And options, that is the put/call ratio or “sentiment”, creates some insight into the underlying securities. So, another fundamental analysis of a security would be found by checking out the CBOE put/call ratio as an inverse correlation. The CBOE put/call is generally an indication of public expectations. This means that a professional trader would probably bet against it as it represents the herd mentality. But the OEX put/call ratio is suppose to follow the smart money and woud not be an inverse indicator. (?) If you’re trading the S&P 500 or Nasdaq 100 the VIX or VXN are inverse correlations giving the fundamental sentiment to those indexes.

“Days to Cover is a formula which tracks the number of shares short in the market relative to the available float. This allows a trader to see how bearish or bullish traders are on a security. The last component of the ratio is the amount of daily volume. If you know the number of shares short and compare that to the average daily volume, you can estimate how long it would take for the short sellers to exit their positions. This ratio gives a trader a rough estimate of how much buying pressure is present in the market for a security.” (mysmp.com)

Beyond the VIX is the spread between the S&P cash and the S&P futures contract called the premium or discount. The fundamental factor to watch here is that the futures market usually leads the cash market. As the spread widens it basically indicates that the cash market should move higher and visa-versa.

Then comes the COT Report. “The COT report shows how large speculators, commercials and small traders have placed their bets in the futures markets in terms of open interest information based on the previous Tuesday, and is an invaluable tool you can use to track the market sentiment in currencies, commodities and stock indices. The only limitation of the COT report is that it is three days late, but that doesn’t mean you can’t still use it as a sentiment tool.” (Dailymarkets.com) Here is the video showing how David explains it’s importance to futures traders.

Also, for futures traders, is the seasonality reports from Moore Research Center.

MRCI’s Editor Jerry Toepke for Dr. Van K. Tharp’s book, Trade Your Way to Financial Freedom: “These annual cycles in supply and demand give rise to seasonal price phenomena — to greater or lesser degree and in more or less timely manner. An annual pattern of changing conditions, then, may cause a more or less well-defined annual pattern of price responses. Thus, seasonality may be defined as a market’s natural rhythm, an established tendency for prices to move in the same direction at a similar time every year. As such, it becomes a valid principle subject to objective analysis in any market.”

Taking a fundamental approach to trading might lead you to check the announcements and possibly setting alerts especially during earnings season. Earnings season can generate a lot of volatility in the market. It is not uncommon for the VIX to have a number of spikes this time every quarter. “The most volatile of all earnings seasons is in late October, which is also the bottom for many bear markets. It is often strong earnings reports from market leaders that can act as a catalyst for the market. Alcoa is the unofficial leader of the earnings season. The stock is one of the oldest stocks listed on the Dow Jones and reports its financials at the end of each quarter. While their is an unofficial start to the earnings season, there is no clear end date. The general rule of thumb is that the earnings season ends 6 weeks after Alcoa reports earnings.” (mysmp.com)

Finally, before opening a long or short position be sure to check the S&P 500, NYSE, Dow, and Nasdaq (whichever applies to your trading) to see how the bulls and bears are doing in the broad market. Keep an ear on the news for surprises, especially natural disasters that could blow up a market very quickly – but not reports by analysts. And, at the very least, check a chart with a longer timeframe than the timeframe you intend to trade.

The S&P 500 is a great index for studying not only the broad market through its futures and the VIX, but also correlations through Beta, how a stock correlates to the S&P, and Beta Diversification.

From correlations and diversification you might wish an even broader economic view of the markets. Potential economic contraction or expansion is viewed through the Ted spread. The TED spread measures the difference between the yield on the 3-month Treasury Bill (T-bill) and the value of the eurodollar futures contract—which is based on the 3-month LIBOR. An even broader view can be found in the LIBOR-OIS Spread.

Actually, this fundamental approach boils down to doing your homework before applying your strategy to a trade – much like the Turtles were handed their volitility tables each Monday morning, did the math, and then searched for trading opportunities.

The Wall Street Courier puts out all kinds of market indicators and an ebook that expalins the most popular ones: eBook of Technical Market Indicators.