To uncover hedging opportunities for clients, electricity market analysts traditionally rely on one of two methodologies: fundamental analysis of market factors or technical analysis of mathematical models. Analysts from both camps can boast of delivering key insights and favorable returns. But to minimize risk, are you better served by choosing one over the other—or by leveraging a strategic combination of both?
We believe the answer is the latter: specifically, a customized total market strategy combining the best of fundamental and technical analysis for market environments where upside opportunities and downside scenarios require continual assessment.
To understand our position, it’s important to see how fundamental and technical analysis differ. Fundamental analysis looks at the supply/demand equation and measures historical behavior to help predict future behavior of electricity pricing. Variables like the cost of generation (natural gas cost), government regulations and policies, weather patterns (cloud coverage, dew point, relative humidity and temperature), peak vs. non peak hours, overall consumption and more can have varying degrees of impact on futures prices at any given point—potentially becoming more subjective when factoring in uncertainty and emotional trading.
Taken alone, fundamental analysis has its limits: even with a solid understanding of a security, determining specific market entry points is not as clear as the individual factors themselves. What one group might deem as a positive sign of decreasing price, another group might see as price neutral given the weight or influence of the variable.
Technical analysis, on the other hand, determines future price action through a series of methods and tools analyzing statistics generated by market activity, past prices and volume. Technical analysts make recommendations based on high and low price points, lines of support and resistance, trend and range indicators, and more.
Like fundamental analysis, technical analysis can carry its own risk; most significantly, false reads or “fake outs,” where data suggests one thing and the market reacts in the opposite manner.
Neither methodology is flawless, which is why you may be best served by combining the best of both. Our recommendation is to begin by studying fundamentals to determine how futures (fixed or hedge price) compare with known variables, aided by research that goes well beyond easily accessible public information to shed light on unconventional back stories in the electrical industry. This would then be augmented by technical analysis to assist with determining where price may go within a specific time horizon. Working together in this manner, both fundamental analysis and technical analysis can provide deeper, more refined insights into securing optimal pricing for you considering your hedge horizon and risk tolerance in any market environment.
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