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The Top Technical Indicators For Commodities


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By Prableen Bajpai, CFA (ICFAI) | October 23, 2014 8:01 AM EDT SHARE

The primary motive for any trader


trader,, investor or speculator is to make trading as profitable as
possible. Primarily two techniques, fundamental analysis and technical analysis,
analysis, are employed for
making buy, sell or hold decisions. The technique of fundamental analysis is believed to be ideal for
investments involving a longer time period. It is more research based; it studies demand-supply
situations, economic policies, and financials as decision-making criteria.

Technical analysis is commonly used by traders, as it is appropriate for short term judgment in the
markets--namely, deciding a quick buy and sell, entry and exit points,
points, etc. It is pictorial; it analyzes
the past price patterns, trends and volume to construct charts in order to determine future
movement. These techniques can be used for trading all asset classes ranging from stocks to
commodities.. In this article, we will concentrate on commodities, which include things like cocoa,
commodities
coffee, copper, corn, cotton, crude oil,
oil, feeder cattle, gold, heating oil, live cattle, lumber, natural gas,
oats, orange juice, platinum, pork bellies,
bellies, rough rice, silver, soybeans, sugar, etc.

Identifying the Market

The most popular indicators for commodity trading


fall under the category of momentum indicators,
which follow the trusted adage for all traders, buy
low and sell high. These momentum indicators are
further split into oscillators and trend following
indicators. Traders need to first identify the market
i.e. whether the market is trending or ranging before
applying any of these indicators. This is important
because the trend following indicators do not
perform well in a ranging market; similarly, oscillators
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tend to be misleading in a trending market.
market.
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Lets take a look at some of these indicators which are considered well suited for commodity trading.
Zero Day Attack
Effective Tax Rate
Moving Averages
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One of the simplest and most widely used indicators in technical analysis is the moving average (MA) JOLTS
which is the average price over a specified period for a commodity or stock. For example, a 5-period Debt Ceiling
MA will be the average of the closing prices over the last 5 days, including the current period. When
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this indicator is used intra-day, the calculation is based on the current price data instead of closing
price. The MA tends to smoothen out the random price movement to bring out the concealed trends.
It is a lagging indicator and is used to observe price patterns. A buy signal is generated when the
price crosses above the MA from below (bullish sentiments) while when the price fall below it from
above is indicative of bearish sentiments hence a sell signal.
signal. The MA is smoother and less sensitive
in case of a long period vis--vis a short time period. The crossover by a short-term moving average
above a longer term MA is suggestive of an upswing.
There are many versions of MA which are more elaborate like exponential moving average (EMA (EMA),
),
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volume adjusted moving average, linear weighted moving average, etc. MA is not suitable for a
ranging market, as it tends to generate false signals due to prices moving back and forth. Remember,
the slope of the MA reflects the direction of the trend. The steeper the MA, move is the momentum Search News, Symbols, Terms Newsletters

backing the trend, while a flattening MA is a warning signal as there might be a trend reversal due to
reduction in momentum.

The blue line


depicts the 9-
day MA, while
the red line is
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the 20-day
moving
average and
the 40-day MA
is depicted by
the green line.
Among these
the 40-day MA
is the
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smoothest and least volatile while the 9-day MA is showing maximum movement with 20-day MA in
between them. (See: Simple Moving Averages Make Trends Stand Out)
Out)

Moving Average Convergence Divergence (MACD)

Moving Average Convergence Divergence popularly known by its acronym MACD is a commonly used
and effective indicator developed by Gerald Appel. It is a trend following momentum indicator that
uses moving averages (MA) or exponential moving averages (EMA) for calculations. Typically, the
MACD is calculated as 12-day EMA minus 26-day EMA. The 9-day EMA of the MACD is called the signal
line and helps in identifying turns.

A bullish signal is generated when the MACD is a positive value as the shorter period EMA is higher
(stronger) than the longer period EMA. This signifies increase in upside momentum but as the value
starts declining, it shows loss in momentum. Similarly, a negative MACD value is indicative of a
bearish situation and if this tends to increase further it suggests a rise in downside momentum. If
negative MACD value decreases, it signals that the down trend is losing its momentum. There are
more interpretations to the movement of these lines like crossovers; a bullish crossover is signaled
when the MACD crosses above the signal line in an upward direction. (Further reading: Exploring
MACD).
Oscillators and Indicators: MACD).

In the chart, the MACD is represented by the orange line while the signal line is purple. The MACD
histogram (light green bars) is the difference between the MACD line and the signal line. The MACD
Histogram is plotted on the centerline and represents the difference between MACD line and the
signal line shown by bars. When the histogram is positive (above the centerline), it gives out bullish
signals as the MACD Line is above its signal line.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a popular and an 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; however traders use their desertion about
setting their preferred parameters. The use of a 14-day RSI was recommended by Welles Wilder but
overtime, 9-day RSI (trade short cycle) and 25-day RSI (intermediate cycle) have gained popularity.
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The popular ways to use RSI is to look for divergence


and failure swings in addition to overbought and
oversold signals. Divergence occurs in situations
where the asset is making a new high while RSI fails
to move beyond its previous high, this signals an
impending reversal. Further if the RSI turns down to
below its previous (recent) low, a confirmation to the
impending reversal is given by the failure swing. (See:
Points)
Relative Strength Index And Its Failure-Swing Points)

To get more accurate results, be aware of a trending market or ranging market since RSI divergence
is not good enough indicator in case of a trending market. RSI is very useful especially when used
complementary to other indicators. (See:
(See: Exploring Oscillators and Indicators: RSI)
RSI)

Stochastic

George Lane based the Stochastic indicator on the observation that, if the prices have been
witnessing an uptrend during the day then the closing price will tend to settle down near the upper
end of the recent price range while if the prices have been sliding down, then the closing price tends
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to get closer to the lower end of the price range. The indicator measures the relationship between
the assets price closing price and its price range over a specified period of time. The stochastic
oscillator contains two lines. The first line is the %K which compares the closing price the most Search News, Symbols, Terms Newsletters

recent price range. The second line is the %D (signal line) which is a smoothened form of %K value
and is considered more important among the two.

The main signal that is formed by this oscillator is when the %K line crosses the %D line. A bullish
signal is formed when the %K breaks through the %D in an upward direction. A bearish signal is
formed when the %K falls through the %D in a downward direction. In addition, divergence also
helps in identifying reversals. The shape of a stochastic bottom and top also works as a good
indicator. Say for example, a deep and broad bottom indicates that the bears are strong and any
rally at such a point could be weak and short lived.

A chart with %K and %D is known as Slow Stochastic. The stochastic indicator is one of the good
indicators which can be clubbed best with the RSI among others. (See: Exploring Oscillators and
Oscillator)
Indicators: Stochastic Oscillator)

Bollinger Bands
Bands

The Bollinger Band


Band was developed in the 1980s by John Bollinger. They are a good indicator to
measure overbought and oversold conditions in the market. The Bollinger Bands are a set of three
lines; the center line (trend) with an upper line (resistance) and a lower line (support). When the
price of the commodity considered is volatile, the bands tend to expand while in cases when the
prices are range bound there is contraction
contraction..

Bollinger Bands are helpful to traders to detect the turning points in a range bound market; buying
when the price drops and hits the lower band and selling when price rises to touch the upper band.
However, as the markets enter trending, the indicator starts giving false signals especially if the price
moves away from the range it was trading. Among other uses, they are considered apt for low
frequency trend following. (See: The Basics Of Bollinger Bands)
Bands)

The Bottom Line

There are many other technical indicators which are available to traders and picking the right ones
is crucial. Make sure of their suitability to the market conditions; the trend-following indicators are
apt for trending markets while oscillators fit well in a ranging market conditions. Applying them in
the opposite
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way can result
in misleading
and false Search News, Symbols, Terms Newsletters

signals
resulting in
losses. For
those who are
new to using
technical
analysis, start
with simple
and easy to
apply
indicators.

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