Most people with any sort of interest in markets and trading are familiar with fundamental analysis, if not by name. In fact, most of the public discussion of financial subjects is focused only on fundamentals such as inflation, interest rates, earnings, debt levels, lawsuits, political developments and other points of interest to fundamental analysis. Unfortunately, most of the discussion of fundamentals is beset by three types of problems.

By far the biggest problem with most discussion of fundamental analysis is that it becomes a distraction from the hard reality of prices. No matter what the fundamentals indicate, traders don't have the luxury of placing their transactions at prices based on their view of fundamentals or any prices other than market prices for that matter. Despite the constant stream of fundamental analysis coming from the media and the finance industry, there are three pieces of information that trump everything else: the price you pay when you buy, the price you get when you sell and the number of units that you place your order for. Other information about the instrument, the sector, the political climate or any other fundamental data might be interesting reading in the paper, but none of these supercede entry, exit and quantity.

Another problem with fundamental analysis is that it's never entirely clear what order to place just based on news events. This difficulty can occur for a variety of reasons.

• Directional confusion

  Just because a trader knows what the events are is no guarantee that the trader will know what to do next. For example, suppose that that there is a new tax cut proposal being discussed in Washington. One point of view would suggest that this might be a stimulus for economic growth and a reason to take a bullish position. Alternately, an increased budget deficit may result in a combination of rising interest rates and inflation, suggesting a bearish position. The end result of all this fundamental analysis is the conclusion that prices might go up and they might go down, which is nothing the trader wouldn't have known from the start.

• Comfort bias

  Most market participants tend to be more familiar with some aspects of the economy and less familiar with others. This is easy to spot when a software engineer, an attorney and a doctor each discuss their views on the markets. The software engineer will be enthusiastic about some tech stock and the doctor will be interested in a company trying to get FDA apprval for a new drug. The attorney will be more interested in the outcome of a prominent antitrust suit. In each case, this attitude will lead to dangerous overemphasis on a small piece of the economic picture.

• Ideological bias

  No one can deny that political events have a huge influence on the world's financial markets. However, traders are often tempted to look at political developments through partisan lenses. If one political party gains ground, doctrinaire supporters of that party will take a second mortgage to increase their investments. Opponents of that party will be convinced that the sky is falling and base their trades on unwarranted fear. Both sides lose because they assume that politicians will implement their preferred changes unilaterally. In reality, it's the individual policies, not political personalities that have the greatest effect on the economy.

• Wrong fundamentals

  This is perhaps the most unfortunate of the problems with fundamental analysis. From time to time central bankers and policy makers are misleading about their policy goals, corporate executives release untruthful earnings reports or media personalities fail to tell the whole story about the events they report. We certainly hope that these events are rare, but by the time the truth comes out it's often too late for traders who have lost money due to trusting dishonest sources of fundamental data.

As the examples illustrate, fundamental analysis is several steps removed from a good trading plan and there are quite a few obstacles on the way.

Technical/Fundamental Disagreement

Some traders, in an effort to deal with some of the shortcomings of fundamental analysis, will attempt to use a hybrid approach to the markets. Fundamentals still play a role in trade selection, but technicals are also a component in the decision making process. This is a very popular approach, but it's not much of an improvement over fundamentals only. We'll go ahead and assume that a trader's technical analysis doesn't have any problems of its own.

When the fundamentals and technicals agree, one form of analysis is superfluous. What happens when they disagree? If the trader just goes with the fundamentals, it's hard to beleive that the trader was ever really using technical analysis in the first place. On the other hand, the trader could go with the technicals but then the use of fundamentals seems questionable. Often, hybrid traders will stay out of the markets until the fundamentals and technicals agree. Such a plan might seem prudent but this is hardly the case. Many of the best trade setups occur when there is a divergence between fundamental and technical indicators.

Feel Good Fundamentals

When market commentators discuss fundamental analysis, they give the impression that the information they are describing is intended for use in planning and placing trades. More commonly, fundamental traders will use fundamentals not to place trades but to justify trades that they have already placed. If a fundamentalist buys stock in an airline and loses money, he can blame his losses on the employees' union. If he loses money in a tech stock mutual fund, he can blame his losses on the outsourcing of tech jobs.

No matter what happens, his losses are not his fault. They are just the result of the events on TV or in the paper. When a trade works out, he can claim to be an expert interpreter of financial and political events who saw the opportunity before anyone else had put the story together. Used in this way, are the fundamentals really relevant to trading? Or are they just a way to try and feel good about bad market discipline?

What's Left?

With all of the problems associated with fundamental analysis, the obvious question is what fundamentals are good for, if anything. For individual trades, fundamentals are useless or possibly worse since they motivate traders into taking questionable positions. Success in the markets requires a consistent, effective approach. News stories about fundamentals don't provide that. The iSigma newsletter does.