In today's complex trading environment, market players need both kinds of analysis to understand price movement better.

G. Chandrashekhar

Fundamental and technical analysis are tools available to market participants to understand price movements. Of course, there is always a debate on what drives the market fundamentals or technicals.

In fact, there are a host of factors such as demand-supply, production-consumption, exports-imports, inventory, weather, government policies, taxes, exchange rate, freight and so on, as well as changes therein. Besides, there are external impacts such as of inflation, interest rates, economic growth and geopolitics.

We also know that markets move based not only on current fundamentals but also changes in future. The price movement of a particular commodity reflects the view of the majority of players in that market.

This view can, however, alter dramatically. For instance, a sudden change in government policy or emergence of a weather concern can instantaneously alter the price perception. In view of these uncertainties, traders and investors need tools that can indicate to them the likely direction of the market.

The big picture

What does a fundamental approach mean? Very simply, one looks at a set of data, including production, consumption, trade and stocks, and then decides whether the market is in deficit or surplus or balanced.

It is simple economics and common sense that if the market is in deficit (demand greater than supply), prices will rise, and if the market is in surplus (supplies exceed demand), prices willfall.

Take any commodity. Opening stock plus production plus imports would give total supplies. Consumption plus exports would be disappearance; and then there is closing stock. An analysis of production, consumption, trade and stock data would give a fairly good insight into the surplus/deficit situation and, thereby, the direction of prices.

This, of course, is one of the simplest ways of looking at a commodity from a fundamental perspective. In real life, a fundamental approach to price forecasting is complex. Estimation of demand or production is not easy. Production could be cyclical or demand could be stagnant or spiking. Income or price elasticity may come into play in demand estimation.

In case of production, besides weather, factors such as cost of inputs and quality of output are relevant. Initially, fundamentals ruled, with supply and demand controlling the underlying price mechanism.

Even today, fundamental analysis is important. The overall demand and supply numbers do move the market.

Yet, the market has become difficult to trade from a strictly fundamental perspective. Market dynamics today are much more complex than fundamental analysis would suggest. Non-fundamental factors too have become important.

Each futures market is different, yet, fundamental reports follow largely the same pattern. The fundamental approach to agricultural commodities would be different from, say, non-agricultural commodities, because of the differing nature of factors in terms of their magnitude, direction and periodicity.

Tracking patterns

As commodity markets matured and technology became acceptable, technicals have gained dominance vis-à-vis market analysis. Commodity markets attempt to achieve price discovery and go beyond. They explore the potential of the unknown. This is where technical analysis comes in.

It is strongly believed that there is a pattern to life's every movement. This is true of the market too. It is axiomatic to technical analysts that there is a pattern in market movements.

These analysts study the pattern of historical price changes and predict future movements.Technical analysis is as much an art as a science. No single programme is 100 per cent accurate all the time.

The perception of each analyst and interpretation of a given set of data may vary and therefore conclusions may differ. Yet, technical analysis is known to give confidence to traders in making their decisions. Institutional investors and large traders use trends and moving averages, while intermediate traders use swings (one/three-week trends). Short-term traders watch daily or intra-day charts.

In sum, it is not about choosing fundamentals

or

technicals, but needing

both

. Good traders follow both in their trading approach. Trading success depends on how well a trader reads and understands price signals.

(Please send suggestions and queries to younginvestor@thehindu.co.in, or The Research Bureau, The Hindu Business Line, 859-860, Anna Salai, Chennai-600002.)

(This article was published in the Business Line print edition dated June 24, 2007)
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