📈 Technical Commodity Market Analysis

“Fundamentalists that don’t pay attention to the charts are like a doctor who says he’s not going to take a patient’s temperature.” — Bruce Kovner

The previous article focused on the power of fundamental analysis: understanding the supply and demand of a commodity, and then taking a view as to how those factors are likely to evolve in the future. This article looks at how you can use technical analysis, which is essentially looking at past price movements to indicate where prices are likely to move to in the future.

As with both fundamental and technical analysis, there are no sure-fire indicators that work all the time, and under all market conditions. However, using these tools helps to move the odds in your favour.

There are many free and affordable services that enable you to calculate and view technical indicators like the MA. Try tradingview.com, investing.com, barchart.com or any of the spread-betting companies (e.g. IG.com).

Moving Averages

One of the simplest and most widely used indicators in technical analysis is the moving average (MA), which is the average price for a commodity over a specified period. The MA is a trend following tool that lags the market, rather than anticipating the market. The MA is valuable as it helps you identify what the current trend is and when the trend has turned. MA’s help commodity investors capture the biggest portion of a major trend — arguably the most profitable way to making money trading commodities.

To calculate a MA (for example, the 30-day MA) simply take the average closing price for the commodity of interest over the last 30 days — including the current period — and divide by the number of days, 30. As the MA stretches back into the past you will see a smoothed line that ebbs and flows with a slight lag to the underlying price.

A very simple way of using MA’s to trade would use the following rule:

  • If the price has dropped below the MA line when the market closes, a sell signal is generated.
  • If the price rises above the MA line when the market closes, a buy signal is generated.

How many days should you use in your MA? It really depends.

For short-term traders anything from 5 days to 50 days might be appropriate. Shorter MA’s are more sensitive, and while losses might be smaller your chances of capturing a big move are lower.

Longer-term traders might focus on the 100-day or 200-day MA. Longer MA’s are less sensitive, and so there is a risk of missing the start and the end of a trend. The potential profits are bigger, but also the chance of a larger loss (Chart 1).

Chart 1: Brent crude futures against 50-day MA (red) and 200-day MA (grey)

Trendlines & Channels

A trendline is a straight line which is drawn on the chart you are analysing. For rising markets, the trendline is drawn so that it touches the bottom price bars between two higher lows. The opposite should be used for declining markets — the trendline touches the top price bar between two lower highs. Two points is the absolute minimum, but the more data points that touch the trendline the greater confidence you can place in its significance (Chart 2).

Trendlines can be used in combination with the MA to determine whether a market is moving along a major trend. However, care needs to be taken. The steeper the trendline the shorter its likely duration and the greater the likelihood that the trend will be broken. Remember too that not all markets trend well all the time.

A channel is in place if a parallel trendline can be drawn adjacent to the original trendline — either above the price points in a rising market or below the price points in a falling market. When they occur, they provide an added degree of confidence in the market’s direction.

A general rule of thumb is that when a market trades above the upper channel (in a rising market), or below the lower channel (in a falling market) the probability that it is entering an accelerated phase have increased sharply.

All the online services previously mentioned allow you to draw lines on the price chart to help identify trendlines as well as other patterns discussed in this article.

Chart 2: Channel in soybean market

Support & Resistance

Support can be defined as a price at which buying interest develops or has developed in the past. You can clearly see this on a chart when the price consistently bounces off a certain price level (or floor). If the market breaks support (falls through the floor) then this is a bearish signal — a sign that prices are likely to continue to decline.

Resistance is the mirror image of support and can be defined as a price at which selling interest develops or has developed in the past (akin to a ceiling). When the price consistently hits a certain price ceiling then this is likely to be an area of price resistance. If the market breaks resistance (pushes through the ceiling) then this is a bullish signal — a sign that prices are likely to continue to rise (Chart 3).

Consolidation & Breakouts

A market is in consolidation when it trades in a relatively flat range: bouncing between support (the floor) and resistance (the ceiling). One way to think about a consolidation zone is that neither bulls (those hoping the price goes up) or bears (traders betting on prices falling) have won the battle.

The longer the consolidation the more confident traders will be that they can buy when prices are at support and sell close to resistance, and vice versa. The longer the consolidation though the more significant a breakout becomes. If a breakout occurs with high trading volume then it’s more likely that it will be sustained, and not fall back.

Once a breakout is confirmed it is not uncommon for the price to fall back to the level previously set by resistance. Instead this price level now becomes support, setting a floor for prices for their next move, or vice versa (Chart 3).

Chart 3: Congestion zone in silver showing false breakout, support becoming resistance after downward breakout followed by final upward breakout

Classic Chart Pattern 1: Heads & Shoulders (H&S)

The most famous, and arguably the most reliable chart pattern is known as the head & shoulders (H&S). The head is a price peak which has another peak lower than the head and to the left (the left shoulder), and another peak lower than the head to the right (the right shoulder).

The line connecting the bottom of the shoulders and head is known as the neckline and is much like the support level described above. It can be horizontal, or upward or downward sloping.

The larger the pattern and longer the H&S takes to develop the bigger the subsequent move in price is likely to be. The pattern is only completed once the right shoulder is complete and the price falls below the neckline. Always wait for it to complete before trading it (Chart 4).

The H&S can also be upside down. This is known as the inverse H&S. The same rules apply but in reverse.

Chart 4: Downward sloping head and shoulders pattern on sugar

Classic Chart Pattern 2: Triangles

Triangles are a type of congestion pattern and come in three distinct shapes: symmetrical, ascending and descending. As with the earlier discussion on congestion, these patterns represent a battle between bulls and bears which gets closer and closer as the triangle narrows. The best breakouts occur approximately two-thirds of the way along the triangle and occur with an increase in volume.

The symmetrical triangle has an equal slope on both sides. It is not clear which way the market will go until the price breaks out of the triangle.

An ascending triangle has a flat upper side (resistance) and a rising lower boundary (support). This indicates that buyers can support the price at successively higher prices. The price tends to break out through the top of the triangle, especially if its part of a longer-term uptrend in prices.

A descending triangle has a flat lower side (support) and a declining upper boundary (resistance). This indicates that sellers can push the price down towards successively lower prices. The price tends to break out through the bottom of the triangle, especially if its part of a longer-term downtrend in prices (Chart 5).

Chart 5: Descending triangle with breakout below support level in silver

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a popular and easy to apply technical momentum indicator. It attempts to determine the overbought and oversold level in a market on a scale of 0 to 100, thus indicating if the market has topped or bottomed. According to this indicator, the markets are considered overbought above 70 and oversold below 30 (Chart 6).

Again, as with the other chart based technical indicators any online chart tool will allow you to calculate the RSI for any commodity market.

Chart 6: Gold price with RSI

Open Interest

Commodity futures markets are zero sum, for every buyer there is a seller. The open interest is the total number of commodity futures contracts bought by buyers or sold by sellers on any given day. Open interest can be interpreted as the willingness of buyers and sellers to maintain their opposing positions in the market.

How can this help you make money in commodities? There are 4 rules to be aware of.

  1. If prices are trending up or down and open interest is also rising, then this indicates the price trend is more likely to continue.
  2. If prices are trending up or down but open interest is declining, then the price trend is less likely to continue.
  3. If prices are in a congestion range and open interest is rising this tends to be bearish for prices.
  4. If prices are in a congestion range but open interest is falling this tends to be bullish for prices.

Data on open interest is published by the US Commodity Futures Trading Commission every week in their Commitment of Traders (COT) report. Several investment banks also publish their own summary of the data.[1] [2]

[1] https://www.cftc.gov/MarketReports/CommitmentsofTraders/index.htm

[2] Saxobank for example publish a weekly summary of the COT report, including what has happened to open interest https://www.home.saxo/en-gb/insights/news-and-research/authors/ole-hansen

TL;DR — How To Think About Using Technical Commodity Analysis

As with all technical indicators it is important to not become too reliant on any single one, but instead use a combination. As I outlined in the previous article on fundamental analysis, often the best trades can occur when both technical and fundamental indicators align. The successful trader or investor needs to be nimble though, and aware that markets can change very quickly, and so you may need to adjust your position if information no longer confirms your original position.

Here’s A Little Checklist/Framework To Help

This article was written by our special guest writer, Peter Sainsbury. Peter is the author of Commodities: 50 Things You Really Need To Know & Crude Forecasts: Predictions, Pundits & Profits In The Commodity Casino. Thank you for reading! Let us know if you found this helpful. You can connect with us @VNewsletters, or check out our website for more information @ vaultcomms.com.




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