Why Reading Analyses is Useful for Trading

Over time, we’ve received some comments as to why analysis is necessary and whether it is actually useful to traders. Such remarks have been around for a long time and deserve their own proper response. To that end, we have compiled a (non-exhaustive) list of the most common comments/criticisms we have been on the receiving end of, along with a refutation for each.

1. Why should traders read any analysis?

As any trader, novice or expert, knows, the world is a complicated place. In order to fully understand what is going on in the world and how it affects your trades one needs to keep abreast of all that is happening. To use a practical example, suppose that one was long the EURUSD in the first week of January, on account of the longer-term trend, forgetting that the NFPs were about to be released. That person would have been in for a nasty surprise, as the pair made a 41-pip movement within minutes of the announcement.

Such a move, which came at a large cost for some traders, could have perhaps been avoided if they had just followed up on the news and analyses. While we are not suggesting that reading analyses would make every trader successful, the extra information obtained could provide useful for some as it will help them make more educated decisions.

2. Why shouldn’t traders just follow the news?

That would be one option. However, the news just offers an overview of what events are due and not how they are expected to turn out. The trader mentioned above could likely have been more educated as to how the market could move and would have likely been able to protect his investments more carefully if he had just read our post that day.

Perhaps the most important point of reading analyses is that it can help traders. However, it takes time to study all the news and developments, and it takes even more time to fully comprehend them. Having a ready-made analysis makes life easier as it offers an overview of the most important events and their implications in a concise manner. This offers the trader the opportunity to gain more knowledge in less time, allowing him or her to devote more time to actual trading.

3. Should traders just read up on what’s going to happen on that day then?

We wouldn’t be that limiting. Markets are huge discounting mechanisms, absorbing news which could potentially take a couple of years to materialize. For example, if one was going through our analyses, then one could have spotted that we mentioned the drop in US corporate profits as a result of the trade war, back in October (twice actually). Using this, traders could have anticipated the stock market decline, if one read the first post, or at least that it would get worse, if one read the second. This could have help the traders who were on the long side to take much more informative decision of whether to choose to sell or continue holding their position. Of course, this would assist traders who would not be willing to carefully consider how this could affect their positions while reading an analysis just for the sake of reading it would not have really had any added value.

4. But if someone is not telling traders what to buy/sell and at which point, why should they read it?

Proper analyses should not direct anyone as to what trades they should do, and neither should they provide any type of investment advice. The purpose of analyses is to provide insights into the markets and their developments and not give out buy or sell recommendations. These decisions should be left to each trader.

Elaborating on the above, traders should never feel safe about making a trade instructed by others; instead they would be better off reaching the point of fully understanding what they are doing by themselves. If this does not appear correct, just see what Jesse Livermore had to say: “If I buy stocks on Smith’s tip I must sell those same stocks on Smith’s tip.  I am depending on him.  Suppose Smith is away on a holiday when the selling time comes around? (…) That is why I don’t believe in tips”.

To put it more succinctly, an analysis is there to help you understand the world and provide potential ideas for trading, but not to specify a trade itself. Putting the idea into play is what the trader’s job is all about. Besides, if, for example, an analyst suggests that the US economy is going into a recession, there are a myriad of ways to exploit this: short the Dollar, go long on the Yen, short the USA500, short the USA100, buy the US10YR, and so on. Suggesting a trade would mean that the analyst is really restricting the trader, since the latter could find more profitable opportunities elsewhere, especially if little rationale is offered for the buy/sell suggestion.

To sum up, analyses offer overview for the potential direction of the economy or provide technical analysis limits. Traders need to look into both in more detail, and make up their mind on their own before they decide whether they should proceed or not, given that perhaps they can judge that the analysis is erroneous. If someone wishes to simply follow orders then an authorized Portfolio Management would be much better suited for this.

5. If analysts knew how to trade wouldn’t themselves be trading?

Despite the fact that this question is often asked, there is a simple answer to it: professional analysts are not permitted to trade for themselves so as to avoid any conflict of interest that may arise.

However, how much would someone really trust an analyst who trades on what he writes on? Think about it. Would you say that the analyst’s opinion is independent, or would he/she be rather biased, aiming to selfishly exploit his position and make trade of his/her own and thus his/her judgement would be clouded? It is likely that we would have the latter in the back of our minds, and thus the reason that market analysts (or any other employee for that matter) are not allowed to trade is due to the fact that this contravenes our Conflicts of Interest policy.

As elaborated above, the analysts’ job is to offer investment research. It is not the analyst’s job to make the trade. That is why in major investment houses there are both “Analyst” and “Portfolio Manager” positions. One complements the other. The Portfolio Manager does not have the time to go through all the ideas because dealing with how to trade the ideas the Analyst brings is already more than a full-time job. Spotting an investment opportunity is mainly the Analysts’ job, but not executing the trade. This division of labour allows for more profitable ideas to arise, hence why paying more than one person to do both tasks is preferred. Again, even though you don’t have to trust us blindly, just think whether it would be a good idea for investment funds to pay for analysts if they did not need them.

On another note on this, there are people who are more equipped to trade while others are more equipped to find potential trades. Thus, condemning an analyst for not trading would be the same as suggesting that a male gynecologist will not be good at delivering babies because he cannot give birth himself.

6. If one is a scalper, why should he/she read any analysis?

Simply put, because news and overall economic developments reach everyone, irrespective of their trading timeframe. Take the NFP example in point #1: even if the trader was in the position for just 1 minute, the candle after the announcement could have caused trouble if one didn’t pay attention to the news or if there was no consideration regarding the impact these could have on one’s trade. Thus, for someone trading the news, actually understanding what could happen is likely to save a lot of trouble and be an important risk management technique.

Granted, the minute trader does not really care about long-term economic developments. However, if a scalper was following the US analysis mentioned in point #3, then he may have gotten some idea as to where to place trades when the earnings reports came out. As such, even in this case, the educated trader stands to potentially benefit by understanding the overall economic environment and how data releases are expected to come out.

7. I don’t really believe in technical analysis.

Many people don’t. But that doesn’t make them right or wrong. For example, there are plenty of independent, academic studies (a review can be found here) which suggest that strategies based on technical analysis can help in outperforming the market. Naturally, this does not mean that everyone using technical analysis will become instantly rich. It takes time, patience, and constant effort to make something work for you; one should also be prepared to fail many times. Some may even find that technical analysis does not really fit their profile and they cannot make it work for them; it would still be useful in providing ideas for trading, given that it can guide traders regarding when to enter or exit a trade, and thus is of much practical use.

8. I agree with the above. Then why should I use fundamental analysis?

Because, in the end, no currency or market can ever escape its economic fundamentals. Even if the markets ignore a worsening in the economic environment for a while (which they usually don’t), they will eventually come to their senses. Fundamental analysis means that one has to understand a country’s economic situation and how that will affect its currency or stock market. By doing this, you reach the level of not just following a trading rule which suggests when to enter and when to exit a trade, but answering the bigger question of why you are doing it. Plus, fundamental analysis, and especially interest rate analysis, is also important in order to determine the swap rate one can possibly pay or earn from a trade. Even for scalpers, fundamental analysis can provide a lot of information given that it is directly related to the data releases we talked about in point #1.

9. Oh ok, the above make sense. But traders get analysis from XYZ, why should someone follow your posts?

We’re not saying that following XYZ is bad. What we’re suggesting is that a trader should get analysis from sources that have a good track record, are up to date, and deal with the things that interest the particular trader. Just like people don’t get news only from one source, it would be good to get analyses from more than one analyst, as people think differently and could offer different (but at times equally correct) points of view. What we are saying is that you could our analysis website a try.

Overall, those were the main comments/questions we have received over time. Naturally, if any of our readers has any more, let us know and we can reply to them in a later post.

 

 

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