Question:
Right after last quarter’s earnings report, I bought put options on Alcoa expecting the stock would drop further because of poor fundamentals. Why has it kept going up and up since?
George from Upsidedownville
Answer:
George, your question takes us to both one of the major misconceptions about trading and the essential element of trading.
When I first started trading, my mentor told me to learn the how to read the fundamentals of markets. I cannot overstate how important this is for a trader. One needs to understand and be able to read the internal structure of markets (fundamentals), and one needs to understand how the changing of the internal structure can move markets up, down, or sideways. This is Trading 101, as far as I am concerned. Learning to read the fundamentals of markets adds knowledge to your toolbox and it increases your “peripheral” market vision. You see more of the big picture when you can read the fundamentals.
Here is the major misconception about this. Although the fundamentals are key to understanding and trading markets, one cannot rely on the fundamentals as the sole factor in selecting a short-term trade. The reason is simple. As I have said before, markets are not rational because our collective psychology drives markets, which means that both perception and emotion play a huge role in creating market direction.
The essential element of trading is that supply and demand determines market price, not the fundamentals. And what drives supply and demand? One would think the answer is self-evident; it is not. Logically, the quantity of a commodity and how badly people want it would define market price, and, in a theoretical world, it is the driver. We, however, live and trade in reality, and in the real world, perception and speculation drive market price. This is true in every single market on the planet. People buy because they perceive a market will go up. This is speculation, short and simple.
Aluminum is no different. Even though the fundamentals appear weak, the driver of the price movement is the perception that the global economy is recovering, and when it does, the demand for aluminum will return. Furthermore, the perception is (rightfully) that China, India, and the emerging global economies (Eastern Europe) will continue to evolve and develop huge middle classes. This too will drive commodity (aluminum) prices up even further over a longer period of time—supply and demand at work, or at least the perception of it.
All of this points to one important factor in successful trading — know your markets, yes, but also know what is going on around them. No market trades in a bubble. Think intermarket analysis.
Trade in the day; invest in your life …
