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Why fundamental trading is so difficult?

Typical investment advisors use the crystal-ball technique called fundamental analysis, which is risky and suboptimal for long-term profit. Fundamental traders guess the future. These traders analyze earnings reports and other company numbers, and predict where the price will go based on their analysis. They have a conceptual idea of where the market will go, and then they make predictions. For example, they might say, “The economy is slowing down, so stock prices will probably go down.” Basically, it’s the Warren Buffett model of investing. That sounds great, except that it’s highly skill based. Buffett is the master in picking the right stocks, and few people are able to learn that skill. They think they can, but when they actually try to pick stocks, they fail.

Using Buffett’s strategy to pick stocks would be like using LeBron James’s strategy to play basketball. Sure, slam dunking every play sounds like a nice strategy in theory, but if the average guy tried it, he would fall on his face. You need Buffett’s otherworldly skill, decades of experience, and hours of daily hard work if you want to attempt his strategy. It’s also difficult for fundamental traders to create strict rules for when to buy and sell, because their discipline is so instinctive and skill based. Quantifying their exact decisions for when to buy and sell is therefore mostly impossible. They make a trade because they expect a certain outcome—that a company is going to do well. But what if they’re wrong? Even the best traders will be wrong frequently. They don’t have an exit strategy, because they’re simply making a bet that a company will do well, and when it doesn’t, they still expect things to turn around eventually. Additionally, fundamental traders don’t tend to have a strategy for when there is a big downturn. Whenever market sentiment is down, their accounts are down, too.

When there is a bad bear market and the markets are down, all sectors go down. All sectors are correlated in bear markets. Diversification works somewhat in bull markets—some sectors will do better than others—but when market sentiment is down, diversification is useless. Your entire portfolio will go down. I call this concept “Lockstep”. It’s when emotional responses create the mood in the market that everything is now going the other way and correlations are either 1.00 (perfectly correlated with zero diversification) or -1.00 (perfectly inversely correlated which means that you can’t make any profits) That’s what happened in 2008.

You can’t predict exactly when the inevitable downturn will occur, nor its magnitude. It could happen in a day, a month, a year, or a decade, and it could be of any size.

At Trading Mastery School, Laurens bensdorp offers a way to backtest if your ideas actually have an edge. We Quantify the whole process, so we have exact buy and sell rules.

Laurens Bendorp

Founder, Trading Mastery School

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