Fundamental analysis involves the study of the basic underlying supply and demand factors that can be expected to influence market price. In the grain markets, such information as the size of the corn harvest, what was left from last years crop (referred to as carryover), expected exports, and feed use will all come into play in helping make trading decisions. When a fundamental analyst sees an imbalance in these types of factors they will develop a trading plan accordingly.
It should be noted that demand and supply are not only significant in physical commodities, like the grain markets. They apply to anything that has a price. It is just that data is much more diverse for things such as stocks rather than soybeans.
Market Fundamentals-Supply and Demand Dynamics
Another thing to remember is that in the longer term, supply and demand are not mutually exclusive. They dynamically interact together. An old grain trader adage is “that the best cure for low prices is low prices.” That’s because low prices discourage small profit margin producers to plant, and encourages higher margin users such as livestock producers to raise more cattle.
Consequently all price effects on supply and demand have the most impact on the marginal market producers and users. It is through this dynamic that imbalances adjust themselves.
The table below shows the USDA corn supply and demand report for April, 2012.
Why We Like Market Fundamentals
From a logical viewpoint there is a certain allure to the idea of trading markets on a fundamental basis. And while there are certainly many excellent traders that have made their fortunes utilizing this method of trading, there are several drawbacks to this approach. To begin, one of the most critical elements of successful trading is cutting losses short. Basically what that means is that you need to know when you are wrong relatively quickly. When using a fundamental approach, the forces of supply and demand are difficult to measure and consequently significant changes are not necessarily easy to detect. As a result, a market can move significantly before the fundamental reason is known. Another drawback is the fact that once fundamental data is released, everyone knows about it. It is often very difficult to come out ahead in the futures markets if you are acting on news that everyone else knows. Due to these limitations even hard-core fundamental traders must use some form of technical analysis to manage risk.