Commodities Trading and Technical Analysis
Most commodity traders incorporate technical analysis into their trading plan. Technical analysis differs from fundamental analysis as it utilizes prior price action to predict future price moves. Fundamental analysis focuses on supply and demand expectations for commodities to predict future price action.
Most commodity traders claim to either be a technical trader or a fundamental trader. In fact, most commodity traders utilize both methods so that they can utilize the best of both worlds. Successful traders know that in the commodities market, a trader can never have enough data and that optimal decisions result from lots of information, the more, the merrier.
To use technical analysis when trading commodities, you will want to start by looking at a price chart of the market you are interested in trading. There are many free sources on the Internet where you can find futures quotes and charts. Following the trend is one of the golden rules of trading so you will want to look for a chart that is steadily moving higher or lower. One of the most popular sayings in all markets is, 'The trend is your friend.'
Basic technical analysis teaches that you will want to buy an up-trending commodity when it is breaking out to new highs, or it has corrected from the recent highs. Overall, technicians look for a robust and well-established trend before stepping into a long or short position.
One important thing to remember about technical analysis is that the same rules apply to all charts, whether they are 5-minute charts for day trading futures or daily, weekly or monthly charts for longer term trading. The first thing you want to do is learn how to read charts and get a basic understanding of what types of patterns and indicators may be an indication of a coming market move. Once you understand the basics, you will be ready to move on to more advanced commodity trading strategies that employ technical analysis.
It is important to understand that technical analysis is not an exact science, it is more of an art form. The same goes for fundamental analysis. You will never be right every time when you trade commodities but the goal is to get markets right more than wrong. Think of these forms of analysis as playing the percentages. If you are right more often than you are wrong, you will come out ahead if you practice discipline and your average loss is the same or less than your average gain.
Charts Tell Us A Lot About Herd Behavior
Technical analysis involves the use of a chart, which is a pictorial that gives you a tremendous amount of data in one simple picture. What I truly love about charts is that it is a guide to market behavior as it portrays the direction that the crowd of producers, consumers, investors, and speculators are going in at any given time.
Charts can tell us a lot about short, medium or long-term herd behavior in markets. Volume and open interest data often confirm or refute the strength of a trend which is highly valuable information. It is important to know if a market is moving in one direction or another because market participants are opening or closing positions. If they are opening positions, it likely means that the buyers or sellers are looking for a move in price, and they are willing to take the risk of losses. If they are closing positions, it like means that they are not taking the risk, rather they are retreating from the market.
Another incredible thing about charts is that they are a great guide market consensus. The wisdom of crowds theory states that crowds tend to make better decisions than individuals over time. That means the chart pattern is always the consensus of the crowd. Trends and chart patterns can change often, but the chart is the representation of consensus opinion at a particular moment in time. That is why the market price for any asset is always the right price. It is the price that buyers and sellers meet in a transparent market and where they transact or put their money where their mouth is.
It is one thing to have an opinion on the direction of a market; it is another to put capital behind that opinion. Charts are useful tools; I find that they are a great compliment to fundamental analysis, and together they are better than each type of analysis on its own.