Hello Traders!
I'm starting this thread to share my understanding of fundamental analysis and how the markets work. Though the drivers impacting individual markets can differ, the principles I outline below are universal.
Then, new information came into the market: Bullard said he believes a 50bps cut would be too aggressive. The new information caused traders to revise their forecasts and reposition. After Bullard, the market priced the July FOMC meeting like this:
One of these outcomes will happen (for simplicity, let's ignore other possibilities like no cut or 75bps). Depending on what the Fed does, traders who bet on a 50bps cut will make money or traders who bet on a 25bps cut will make money. Money is made in the markets by having a more accurate forecast of future events than other market participants.
Now, let's pretend you've done your research and believe there's going to be a 50bps cut. How do you trade it? Technically, the most direct bet would be to go long eurodollars or another STIR product, but I'm guessing not many people trade those instruments here. All else being equal, gold should go up with lower interest rates so going long gold would be sensible if you think the Fed will cut 50bps. This example is just one, there's almost an unlimited set of probabilities baked into the market.
I think most people understand that expectations drive market prices, but my perspective shifted some after reading Howard Mark's Mastering the Market Cycle. He contends that at any given moment an asset's price refects probabilities the market assigns on all possible future outcomes. Market expectations for next month's FOMC meeting are just one of many things influencing the price of gold. In addition to the Fed, other possible future outcomes impacting the value of gold could include:
Once new information comes out, the odds will update, positions will shift, and asset prices will change. You don't have to be right every time, you just need to be slightly more accurate than the market and you'll prosper.
I'm starting this thread to share my understanding of fundamental analysis and how the markets work. Though the drivers impacting individual markets can differ, the principles I outline below are universal.
- Changes in expectations about the future is the primary driver of the markets.
- The price of every asset reflects a range of possible future outcomes.
- Markets move based on new information that changes the market's perception about the probability of future outcomes.
Let me demonstrate with a very simple example. Currently there's a big debate about whether the Fed will cut 25bps or 50bps in July. Two days ago, traders priced it like this (courtesy of bulltrap):
Attached Image
Then, new information came into the market: Bullard said he believes a 50bps cut would be too aggressive. The new information caused traders to revise their forecasts and reposition. After Bullard, the market priced the July FOMC meeting like this:
Attached Image
One of these outcomes will happen (for simplicity, let's ignore other possibilities like no cut or 75bps). Depending on what the Fed does, traders who bet on a 50bps cut will make money or traders who bet on a 25bps cut will make money. Money is made in the markets by having a more accurate forecast of future events than other market participants.
Now, let's pretend you've done your research and believe there's going to be a 50bps cut. How do you trade it? Technically, the most direct bet would be to go long eurodollars or another STIR product, but I'm guessing not many people trade those instruments here. All else being equal, gold should go up with lower interest rates so going long gold would be sensible if you think the Fed will cut 50bps. This example is just one, there's almost an unlimited set of probabilities baked into the market.
I think most people understand that expectations drive market prices, but my perspective shifted some after reading Howard Mark's Mastering the Market Cycle. He contends that at any given moment an asset's price refects probabilities the market assigns on all possible future outcomes. Market expectations for next month's FOMC meeting are just one of many things influencing the price of gold. In addition to the Fed, other possible future outcomes impacting the value of gold could include:
Once new information comes out, the odds will update, positions will shift, and asset prices will change. You don't have to be right every time, you just need to be slightly more accurate than the market and you'll prosper.
Self-sufficiency is the greatest of all wealth. - Epicurus