Commodities Advanced

Bull and Bear Cycles

Those with some commodities trading experience have almost certainly come across the terms bullish and bearish.  Upsurges in price activity and commodities valuations are associated with the positive, or bullish, side of the market. Declines in price activity are associated with the negative, or bearish, side of the market.  But commodities traders must always understand that no market trend can last forever — and there are somewhat predictable stages of growth that can be spotted in advance.

These bull and bear stages, or cycles, can help commodities traders to determine whether a specific asset should be played from the long side or the short side.  So, this information can be highly valuable for investors looking for new trade ideas that involve “buying low, and selling high.”  If a bull cycle in a specific commodity is coming to an end, prices will be very cheap relative to the historical averages.  These lower valuations make it attractive to start building long positions in that asset.  If a bear cycle in a commodity is coming to an end, prices will be very expensive relative to the historical averages.  These higher valuations make it attractive to start building short positions in that asset.

Assessing the Broader Environment

Commodities are essentially the “raw materials” that allow the world economy to progress and grow.  Individual commodities almost always experience unique changes in price that cannot be found in other markets.  But when we look at the commodities space as a whole, it starts to become easier to spot dominant trends.  When commodities are increasing in value, a bull cycle is in place.  When commodities are decreasing in value, a bear cycle is in place.

Bull and bear cycles are ultimately defined by the level of supply and demand that is present in the global financial environment.  But these cycles are also influenced by the monetary policy decisions that are enacted by central banks around the world.  When central banks are lowering interest rates, commodities valuations are likely to increase.  This is because there is generally a greater demand for raw materials as economic activity starts to pick up.  Conversely, macro environments where central banks are raising interest rates generally experience declining demand (and lower prices) in commodities.

Watching the Major Assets

Another way commodities traders assess market trajectory (and the bull/bear cycle) is to watch the major commodities assets.  It is no secret that most commodities trading is centered in oil and the precious metals, so these are two areas that should always be on the radar for commodities traders.  If we are seeing rallies in oil markets, it is not entirely unreasonable to expect rallies in natural gas and alternative energy markets.  It is important to remember that no commodity trades in a vacuum, and a climate where demand is rising in oil is also likely to be one where demand is rising for energy assets as a whole.

In this way, precious markets tend to move in the same general direction as well.  Gold is always going to be the major player in this space — and receive most of the media attention when we look at the financial news headlines.  If gold is rising, the majority of the market is going to assume a positive stance for the precious metals space as a whole — and this is something that could help to create a bull cycle in metals like silver, platinum, and palladium.  This creates a solid climate for commodities investors to establishing long positions.  Major declines in gold, however, could spill over into the other precious metals and create a bear cycle that would make short positions more attractive.

Production Output

The last factor we will look at when determining the bull/bear cycle is production output.  Improved activity in the global economy is a great way of assessing demand levels for commodities.  But this is only one side of the equation, as economics is always a struggle between the level of both supply and demand that is present at any given time.  Supply levels are just as important.  Rising supply will generally lead to falling prices (bull cycle).  Falling supply will generally lead to rising prices (bear cycle).  A proper understanding of current supply levels is absolutely essential for anyone looking to take active positions in the commodities market.

To determine the level of supply, we must look at the entities that are responsible for producing these materials.  In oil markets, this means looking at the oil drillers and refining companies.  In precious metals, this means looking at mining companies.  In the soft commodities space, this means looking at farming production and the output generated by the major food companies.  These different producers might seem like they operate separately, but there is also a high level of interconnectivity that is seen in conjunction with one another.  Higher oil prices increase costs for metals producers and farmers.  Higher gold prices devalue the US Dollar and increase the price of oil (which is priced in Dollars).

These are all factors that must be considered when commodities traders are looking to establish new positions in the market.  If you are able to accurately assess which factors will drive the next price cycle, you will be able to buy assets while commodities prices are still low — and sell them when prices are still high.  Traders that are able to do this constantly are the ones that will be able to enjoy a long and profitable career with their investments.


Leverage and Protective Trading

If you have made it to the advanced stage in your commodities trading career, you have almost certainly learned the value of proper risk assessment.  Unfortunately, initial stages in the learning process are generally associated with costly mistakes that could have been avoided.  But it is important to remember that these mistakes are all essential parts of the learning process and we usually need to run into a wall once or twice before we can start to truly improve our rates of success.

The most common mistakes come in a variety of different forms.  When many commodities traders are still starting out, there tends to be a much greater focus on the potential for profits rather than on the potential for losses in any given trade.  This is a critical mistake because it is the losses that can truly destroy a trading account.  When traders fail to put potential losses at the forefront of consideration of any investment, there is a tremendous level of unnecessary vulnerability being taken on — and this is one of the first mistakes that must be corrected with real money trades are being placed in the commodities market.

Watching Leverage Levels

But how, exactly, can commodities traders limit risk in a practical way?  One of the first actions to take is to avoid the use of excessive leverage.  Now that commodities broker platforms are accessible in our homes, brokers are competing for your business and offering large leverage for trading clients.  Newer commodities traders often start with small account sizes, so these increased leverage offering can make it seem as though it will be easier to generate significant profits in a short period of time.

But the unfortunate reality is that most of these traders fail — and wind up losing all of the money originally deposited in the account.  What these traders miss is that greater potential for profits can only be seen if there is also a greater potential for losses.  We can’t have one without the other — but this is something that tends to be missed by newer traders.

Appropriate Trading Sizes

So, in order to retain the health of your trading account it is important to pay attention to the the trade sizes that are open at any given time.  Another mistake newer traders tend to make is seen when multiple positions are open at once — and the combined potential for loss is more than the account can handle.  If you are trading with a very small account size, it is more than likely that you will not be able to handle more than one trade at a time.  For these reasons, newer traders need to exercise more patience when deciding on which assets to buy and sell.  Avoid doubling-up on your positions and instead focus on only the trading opportunities with the highest probability for success.

As a general rule, it is a good idea to risk no more than 2-3% of your trading account balance at any given time.  So, for example, if your account balance is $10,000 you should never enter into a trade that could cost you more than $300.  You can limit your potential for risk by placing a protective stop loss in your trade (in the case of futures) or in buying smaller contract sizes (in the case of options).  New traders with very strict rules for limiting losses will probably want to consider trading options, as the exact potential for loss is definitively known from the start.

If you are going to honor the commonly accepted rules limiting risk to 2-3% of your trading account, special attention will need to be paid to the level of leverage that is exercised at any given time.  Some futures brokers offer the ability to deposit as little as 5% of the total contract size for a commodities trade.  Deals like this might seem enticing, as you are required to pay very little for a relatively large contract size.  It is true that this type of practice can lead to massive profits — especially on a percentage basis.

Taking a Protective Stance

But what if the first few trades do not work out in your chosen direction?  The unfortunate reality of any trading scenario is that no setup is a “sure thing.”  Even the most well thought-out trading idea is still vulnerable to the whims of the commodities market as a whole.  So, there is nothing to safeguard your trading account from unexpected volatility in the market if things start to turn sound.

This might sound like a pessimistic viewpoint, with no way to overcome the price fluctuations commodities might experience.  But the reality is that we only need to take a more protective, conservative outlook in order to overcome these negatives.  When we use appropriate trading sizes and levels of leverage, we are limiting risk and keeping our account balance healthy — even in cases where a few trades do not work in our favor.  Your job as a commodities trader is tom settle on a strategy that is consistent, repeatable, and generates profits that are larger than your losses. Your job as a commodities trader is not to try hitting a “grand slam” in every trade.  When these protective rules are followed, long-term success becomes a much more attainable entity.


Commodities Proxy Markets: Energy Companies

For most, creating a price forecast for energy markets can seem like a very daunting task.  But it should be remembered that market prices for commodities can always be viewed in terms of the level of supply and demand that is seen at any given time.  On the supply side, one of the best ways of gauging market activity is to research production activity in the world’s largest energy companies.  Since this is where the vast majority of the world’s energy supplies will be produced, commodities traders can obtain a relatively clear sense of the broad trends that will likely dictate market prices in the coming months and quarters.

In these ways, commodities traders can look at proxy markets in order to find the information that will be needed when constructing an investment bias.  Strength or weakness in the production rates generated by the world’s largest energy companies can be used as a method of assessing the level of energy supply that is available in the market.  If production and supply levels are increasing, it would be reasonable to expect falling energy prices.  If production and supply levels are decreasing, rising energy prices would then be expected.  Here, we will look at some of the ways commodities traders can access this information and use it when establishing an active stance in the market.

Production Factors Involved

Energy markets are often characterized by enhanced volatility when compared to make of the other asset classes.  This volatility often comes as the result of military conflicts and geopolitical tensions that can create unexpected transportation disruptions.  Other factors, like inefficiently managed oil wells can also pose potential problems.  We must only think back to the BP oil spill in 2009 to find an example of ways improper site management can influence oil supply levels in the broader market.  These are some of the events that commodities traders will need to consider before establishing in energy market assets.

Energy Companies to Watch

These operational and geopolitical factors should then be applied to the individual companies that are responsible for most of the world’s energy production.  Some of the key names to watch here include Exxon Mobil, Chevron, Conoco Phillips, British Petroleum, Occidental, GDF Suez, Royal Dutch Shell, Statoil, Halliburton, and PetroChina.  We have started to see an upsurge in energy companies that are based in emerging markets, so commodities traders will need to consider these companies as well in the years ahead.

When you start researching these companies, it is important to have an understanding of the sector in which each corporation operates.  For example, Exxon Mobil devotes most of its attention to the fossil fuel sector, which operates in very different ways when compared to an electric company or an alternative energy company.  So if you feel most confident in assessing the inner workings of an electric company, an oil company like Exxon Mobil will not be of much use in your active trading.  Part of your job when you are researching commodities proxy companies is to separate each corporation based on its specific sector area.

Once you have chosen which companies are most relevant to your expertise and the commodities assets you plan on trading, it makes sense to start watching the quarterly earnings reports that are released by those companies.  These reports will give you a better sense of the production output and the available market supply in the coming months.  Increased production from a company like Exxon Mobil or ConcoPhillips would indicate positive supply trends — a scenario that would ultimately be a bearish event to influence market prices in oil.

When you compile the research list for which companies you are prepared to watch, it is generally a good idea to include no more than 5 or 6 companies.  At the same time, you don’t want your research list to include anything less than three companies.  In this way, you will be able to gain a broad and diversified perspective that will allow you to have an accurate understanding of the true supply trends that are present in the market.  Having less than three companies on your research list will make you vulnerable to the consequences of having a narrow perspective.  Increased or decreased production rates at one company might not be indicative of what is happening in the sector as a whole.  Having more than five or six companies on your research list can start to get cumbersome, and prevent you from conducting research that is sufficiently in-depth.

Conclusion:  Pay Attention to the Companies Producing Your Chosen Commodities

In these ways, commodities traders can broaden their outlook and assess the market in a more accurate way.  It might seem as though the stock market and the commodities market are separate entities that have little or nothing to do with one another.  But those with any experience in active trading know that this is simply not true and that it is important to assess the strength or weakness in energy companies in order to properly assess the supply and demand conditions that are going to impact commodities prices down the line.

You do not need to assess all of the corporate producers in your chosen asset class, but it is a good idea to have a research list of roughly five top companies producing commodities associated with your trading.  This is an excellent way of establishing a market bias and attaining the knowledge you need in order to constantly generate profitable trading ideas.


Commodities Proxy Markets: Mining Companies

When we first start trading in commodities, it might seem as those stock markets have little to do with our trades.  But once we grow in practice and experience, it starts to become clear that this is simply not the case.  It remains true that all financial markets are intimately connected — and this is perhaps most true in the case of mining stocks and metals commodities.

Because of this, those investing in precious and industrial metals will need to have some understanding of the of the inner workings of the world’s largest mining companies.  Research in these areas will help metals traders assess the level of supply that is available in the market.  This information is highly valuable once it is time to start placing commodities trades.  Here, we will look at some of the world’s major player in the mining industry and discuss ways commodities traders can those assessments to help establish an active stance in the market.

Production Factors Involved

The metals market is a widely diverse space, and sometimes it can be difficult to make forecasts on whether its prices will rise or fall in the future.  This is because there is no single exchange or geographic location where analysts can survey the financial climate and assess the level of supply and demand that is present.  So it can be argued that one of the best places to find this information is to assess the level of output that is generated by the largest metals producers.

To accomplish this, there are several factors that must be taken into account.  The metals mines themselves are regionally specific, so it is critical for mining companies to maintain access to the sites with the greatest potential for output.  In some cases, geopolitical issues can make this a complicated process.  But if a mining company is not able to maintain access to the largest pools of resources, supply levels will start to suffer.  Furthermore, mining companies must maintain each site in ways that ensure longevity and successful extraction rates.  If the process is conducted inefficiently, or mining accidents occur, mine closures and delays in production might be seen.  This can limit the available metals supply in the commodities market.

Mining Companies to Watch

All of these factors and assessments must be applied to all of the largest mining companies.  Some of the most important companies in this industry include Alcoa, XStrata, Chinalco, Rio Tinto, BHP Billiton, and Vale CVRD.  The mines owned by each of these companies are diverse and it is relatively rare to see a major mining company that produce only one type of metals.  But, at the same time, these companies to have their respective specialties and we will often see a strong focus on a single asset type.  For example, Alcoa focuses most of its resources on its aluminum projects.  So, if you are a commodities trader that is looking to establish a position in aluminum, quarterly performances in Alcoa will be an important area to research.

Conversely, a company like Rio Tinto focuses on a much broader asset space — and is known for producing many different types of metals.  This ultimately means that commodities traders looking for information on the metals space as a whole will want to pay special attention to the performance rates at Rio Tinto’s mining operations.  Rio Tinto is highly transparent, and makes its financial and mining reports available on its website.  This is an excellent resource for commodities traders that deal in metals.  Rio Tinto also summarizes the net worth of the metals produced, and this is highly valuable when we are trying to assess the level of supply available in the market.

BHP Billiton is another mining company that focuses on several different types of metals production and offers vast research materials on its website.  BHP Billiton is generally known for its strategies to expand aggressively, so if there is evidence of a slowdown at the company it is generally a good indicator that market supply levels will be decreasing.  BHP Billiton is a company of enormous size and is known to always be on the lookout to buy smaller mining companies.  When these types of acquisitions are seen, it is usually a good indication that metals supply levels will increase.

Alcoa is similar in terms of its size, but less similar in the ways it approaches the metals space.  As mentioned above, Alcoa devotes most of its resources to the production of raw aluminum.  Aluminum is a highly pliable metal with a wide range of consumer and industrial applications, and Alcoa’s broad resource base in this area ensures it will continue to be one of the largest mining companies in the world.  But its performance figures are less applicable to the metals space as a whole — and is not likely to be something that will be seen as useful by precious metals investors.

The other companies on this list are smaller in size.  But it is still important to have some sense of the broader production output that is seen at each of these companies.  Quarters that show strong production numbers will likely see declines in metals prices as the excess supply needs to be removed from the market.  In a scenario like this, it would make sense for metals traders to start considering short positions in their chosen assets.  Quarters with weaker production numbers are more likely to see rising prices in metals.  These are scenarios where long positions would make sense.

In these ways, commodities traders are able to connect the stock market to the metals space.  It is always important to have a good understanding of what is happening in mining companies before committing to any trades in the precious or industrial metals.


Assessing Future Trends in Energy Markets

For commodities traders, most of the attention tends to be placed on energy markets and in the precious metals.  But there are some differences in these two diverse areas that should be understood.  From the historical perspective, there have not been many changes in the ways gold, silver, and platinum have traded over time.  These assets are typically used as a safe-haven store of value and as a protective hedge against inflation.

Energy markets, however, are very different.   It is true that for the past century fossil fuels have been the dominant energy source throughout the world.  But petroleum products are a finite resource, and there is little argument to be made with the fact that the world will eventually need alternative energy sources to meet the growing development needs of emerging markets.  Because of this, commodities traders will need to be aware of the changing nature of the energy sector, as there will likely be some incredible investment opportunities in this space in the years ahead.

Long-term Trends

As the world’s supply of oil continues to decrease, most commodities investors expect its value to steadily rise over time.  Decreasing supply and growing demand from emerging market work together to create a broadly bullish picture for oil as a commonly traded commodity.  This does not mean that commodities traders can simply buy oil and profit from every trade.  There will certainly be periods of volatility that sends prices in both directions.  But the long-term trend in oil is still expected to be positive — and this means that any significant declines will most likely be met by investors eager to buy.

But there are long-term expectations for other sections of the energy market, as well.  Specifically, areas like wind power and solar energy are gradually expected to rise in popularity.  When exactly this will start to occur is a subject for debate.  But there is little doubt that investors will be looking for ways to profit from speculative positions in alternative energy markets in the years ahead.  At the moment, these forms of energy are still relatively expensive to produce given the smaller energy output that is associated with their usage.  But investors that are able to get in on these trends while they are still in their infancy will be the investors that stand to capture the greatest profits in these areas.

Wind Power

For these reasons, it makes sense to have some idea of what the market needs to see in order to start building investment positions in alternative energy commodities.  The turbines that generate wind power must be placed in areas associated with high rates of natural wind occurrence.  There are not many geographical regions capable of producing wind energy year-round, and this means that turbines might go unused during periods of low-wind activity.  Furthermore, these wind turbines are exceptionally noisy, and this makes it difficult to place the turbines in residential areas.

Unfortunately, this tends to be where the majority of the power is needed so this is another issue that will need to be rectified before widespread use of wind energy can be expected.  Other factors to consider will the the pricing that is associated with wind energy.  Commodities traders cannot simply buy a “barrel” of wind power in the way they can with oil.  Wind energy itself can be viewed in terms of the number of electrical watts that can be produced, and this is the context in which its value will ultimately be determined by commodities traders.

Solar Power

We have seen some significant strides forward in the production of wind power over the last decade.  But this has not been true to the same extent when we look at solar energy, which is still holding in a much cruder stage of development.  This creates some challenges and potential opportunities for investors, but it must be understood that the solar energy market still has some ways to go before we are likely to see widespread trading.

Solar energy is produced when photovoltaic panels absorb the sun’s radiant energy, and then convert that energy into usable electricity.  At this stage, the main problem with solar energy production comes from the fact that the photovoltaic panels produce a very small amount of energy relative to the size of the panels themselves.  This makes production expensive with relatively little electricity output.  To gain some perspective here, a regularly sized family home would need more than a dozen solar panels in order to meet its energy needs.

Of course, the technology here is improving and it is only a matter of time before we start to see improvements that make solar panels a feasible energy option.  Once this occurs, we will see a tremendous upswell in the amount of speculative investment that will be seen in the commodities markets.  With all of this in mind, it is important for commodities investors focus on the energy sector to remain cognizant of developments that can be found in alternative energy.  Investors that are able to capitalize on these markets in their earliest stages will be the same people able to capture most of the profits once these technologies becomes more economically viable.


Kondratiev Waves

Every successful commodities trader is looking for a way to get an edge on the rest of the market.  Traders that are able to anticipate bullish moves before they occur can buy commodities at cheap prices and then profit from the positive moves that come later.  The same is true for short sellers that are looking to bet against commodities.

There is a wide variety of strategies that traders use in making these assessments — and some certainly have a greater rate of success than others.  But there is less argument with respect to the success rate of strategies that view the market from the longer-term perspective.  Short-term trends are much more volatile, and much less predictable.  So, for traders with a conservative outlook, it makes a good deal of sense to find strategies that assess price activity in a broad manner.  One of these strategies is the Kondratiev Wave Theory, which attempts to predict long-term fluctuations in the market prices of commodities.

Kondratiev Cycles Defined

Kondratiev Cycles occur over a period of 45-60 years, and outline the long-term trends in commodities seen during that time.  Specifically, these cycles are composed of periods of stalling, acceleration, overinvestment, price bubbles, and price busts.  Kondratiev Cycles were first proposed by Russian economist Nikolai Kondratiev in the early 1920s to assess the connection between world price deflation and the gold standard.  So, Kondratiev Cycles have always been intimately connected to the commodities markets.

Kondratiev Cycles themselves can be separated using three general stages:  asset oversupply leaves to stalling prices, central banks then lower interest rates and this leads to increased speculative investment, prices then reach new bubbles that eventually burst.

In the first steps, the economy is progressing slowly as basic infrastructure projects like housing construction, factories, and railroads are few and far between.  To change this, the central bank will generally reduce interest rates in order to spur the economy into a period of faster growth.  This first leads to greater speculation in the stock market, as it is now easier to borrow cash for investments.  This stock buying gives companies the monetary resources it needs to grow their businesses.  This spurs corporate activity, and inflates stock prices — and the momentum attracts investors from all demographics.  Stock prices grow until a bubble is created, and the final result is a market crash that brings commodities values closer to their long-term averages.  Once the cycle is complete, the process starts all over again.

Historical Examples

Using this theory, we can say that the world economy experienced one completed Kondratiev Cycle in the years between 1930 and 1990.   The economic depression of the 1930s came to an end with the wartime efforts that began in the 1940s.  These changing dynamics created an era of gradual economic prosperity in the 1950s and 1960s, and then a period of strong growth in the 1970s and 1980s.  This created a period of accelerated stock performances in the 1990s, which ultimately culminated in the bursting of the “tech bubble” that was created during that period.

The commodities markets ebbed and flowed with the broader economy during these years, so we can see that the Kondratiev Wave Cycle has real world applications that can be used in active trading.  These cycles can be great for determining the broad trends, and assessing where commodities are likely headed in the years ahead.  If commodities traders are able to accurately assess whether markets are in the “boom” or “bust” phase of the cycle, it becomes much easier to determine whether commodities assets should be bought or sold.

Chart Example

In the chart below, we can see a visual representation of how these cycles work.  Here, we can see phases described as prosperity, recession, depression, and improvement:

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Chart Source: Wikipedia

Here, we can see how the Kondratiev Cycle related to specific commodities over time.  Commodities closely related to the deflationary trends that are seen in the economy as a whole.  When price deflation is seen on the global level, commodities will likely follow suit.  Commodities traders should be looking to sell these assets in these types of environments.  When progress starts to be made in the global economy, and Kondratiev trends start to rise, it is generally a good idea to start taking long positions in commodities markets.

Another factor to consider is the rapidly growing nature of the technology space.  Many commodities investors have argued that Kondratiev Cycles will not start to progress more rapidly now that the technology sector is such a large part of the economy.   This means that the trades based on the cycles themselves should be slightly shorter in terms of the time frames used in each trade.  Ultimately, these changes could prove to be much more useful, as the larger number of Kondratiev Cycles will result in more trading opportunities as commodities prices ebb and flow.

If nothing else, the Kondratiev Cycle provides commodities traders with a useful model for viewing the ways markets actually operate.  No market trend can last forever, and the underlying logic that forms the basis of each cycle can be used to establish a basis for what is likely to happen in commodities.  These rules should not be viewed in a rigid fashion, however, as there is reason to believe that the changing nature of the tech space will change the speed with which each cycle completes.


Placing Trades with Moving Averages

Commodities traders that are looking to employ strategies based on technical analysis will need to have a firm understanding of moving averages before any real-money trades are placed.  It is true that there is a wide variety of strategic approaches that use technical analysis methods.  But most of these strategies are based on the historical averages of charted prices, so this is an excellent place to start if you plan to base most of your trading ideas on technical analysis.

Moving averages are useful because they allow traders to view market activity in a more objective fashion.  Price activity in the commodities markets can often become erratic and volatile.  But when we use moving averages, it can become easier to smooth-out these erratic price changes and focus more closely on the true trends that characterize the market.  Traders that are able to accurately assess the underlying trends in the commodities markets have much better chances for success in achieving long-term profitability.  Here, we will look at some of the factors involved when commodities traders base their positions on moving average strategies.

Defining Moving Averages

When plotted on a commodities chart, a moving average takes the average closing price of a set number of periods and then displays that information as a dynamic line.  It is called a moving average because it literally “moves” in tandem with prices and is always changing.  There are two types of moving averages:  the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).  

A simple moving average is a true price average in that it divides all of the relevant closing prices by the number of periods in your chosen time frame.  An exponential moving average is different in that it gives greater weight to more recent time periods.  Neither type of moving average is better or worse than the other, but it is important to understand the differences so that we can understand the trading signals that are being sent.

First, we will look at an example of a 20-day SMA using a real-time silver chart:

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Chart Source: Metatrader

In this example, we can see the 20-day SMA plotted in purple alongside price activity in silver.  When prices are rising or falling, the SMA follows suit and this makes it easier to identify the broader trends present in the market.  In this example, we can see that most of the trajectory is directed to the downside so this information can help commodities traders to see that the majority of the market’s momentum is bearish.

Next, we will look at this same activity plotted with a 20-day EMA:

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Chart Source: Metatrader

At first glance, it might seem as though there are no differences between the plotted values of the SMA and EMA for silver.  But if we look closely, it does become clear that the values are different.  These small differences can become important when we look at the specific trading signals that are sent, so technical traders must remain aware of these factors when placing specific trades using moving average strategies.

Trading Signals

So, how exactly can this information can be used to place real-time trades?  Overall, moving averages are designed to give traders an idea of the directional momentum that is present in the market.  When prices are trading above the moving average, the directional momentum is bullish and long positions should be considered.  When prices are trading below the moving average, the directional momentum is bearish and short positions should be considered.

Let’s again refer to our silver chart utilizing the 20-day EMA:

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Chart Source: Metatrader

Early in this chart history, we can see prices cross forcefully above the 20-day EMA.  This gives us our first signal, which is an indication to start buying silver.  The positive momentum then starts to wane, and prices then change direction to drop through the EMA.  This indicates that commodities investors previously long silver should reverse their positions — and start selling the metal.  A fairly extensive move follows and significant profits could have been captured by those that acted on the moving average signal.

Toward the right of the chart, we can see prices move back above the EMA.  This is an indication that traders should then assume the long side of the market — or at least close the short positions established previously.

Conclusion:  Use Moving Average to Properly Gauge Momentum in Commodities Markets

In these ways, commodities traders are able to use moving averages to assess market momentum and take active positions in the market.  It should be understood that the majority of technical analysis traders will employ moving averages in some form on their commodities charts.  But, even if this is not the case for you, it is still important to have an understanding of how moving averages are used because most charting strategies are based on moving averages in some form or fashion.

Moving averages can be a powerful tool to objectively show what is happening in the market, and can give commodities traders an edge in determining where asset prices are likely to travel next.  For all of these reasons, moving average strategies should be considered by those looking for proven ways forecast upcoming trends in the commodities market.


Trading Commodities Breakouts

There are many advantages that commodities traders can find when employing strategies in technical analysis.  Broadly speaking, technical analysis enables traders to deconstruct the market and view it in terms of its most basic component parts.  When we are able to view market activity in a more objective way, it becomes much easier to make rational trading decisions that are based on logic rather than emotion.  This is especially helpful when trading plans are not working out as expected, and trades must be closed in order to prevent further losses.

But this is also helpful when trade planning is in its early stages.  One example can be seen in breakout strategies, which allow traders to spot new trend activity as it is beginning.  It much easier to capture significant profits if you are able to trade commodities in the direction of the trend before most of that trend has finished.  It might seem difficult to identify trends before they have fully established themselves.  But breakout trading techniques help offer some solutions here, and give commodities investors methods for identifying trending moves before they have fully completed.  Here, we will look at some of the factors involved when commodities investors look to trade price breakouts.

The End of a Trading Range

Price breakouts generally come at the end of a period of price consolidation, otherwise known as the trading range.  In these environments, there is no clear market majority and neither buyers nor sellers are able to establish a firm foothold.  Price volatility slows in these scenarios and momentum largely leaves the market.  This creates upper and lower bounds that are generally defined by relatively clear support and resistance levels.

An example of a trading range can be found in the oil chart pictured below: 

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Chart Source: Metatrader

In this example, we can see prices start with a moderate drift higher before they are later caught between two clearly defined support and resistance levels.  The sideways activity creates the trading range that dominates, and hold through several tests of these support and resistance levels.  But these types of situations cannot last forever, and once these trading ranges break, commodities markets will often experience significant follow through in the direction of the break.

Let’s look at the chart activity that immediately followed this trading range:

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Chart Source: Metatrader

Here, we can see that the trading range holds up well well for some period of time.  But eventually conditions change in the commodities market, and sellers start to take over.  A situation like this might occur for a number of different reasons when we view the market from the perspective of fundamental analysis.  But these are generally not issues that concern commodities traders employing price chart strategies.  All that concerns these traders is the fact that the previous trading range is no longer valid, and there there must be sufficient conditions in the market to start establishing new breakout positions.

In this example, the breaking is bearish which ultimately means that short positions should be considered for oil.  In a bearish breakout, the break of support in the trading range is the critical signal that tells commodities traders that a sell position should be considered.  If this was a bullish breakout, the signal would come with an upside break of the previously established resistance zone.  In both cases, we would be able to see that market conditions are changing, and that the commodities market is beginning to show a clear majority in one direction or the other.

Benefits of Technical Analysis in Breakout Trading

It takes a good deal of momentum to change price direction in the commodities market.  Remember, this is a global financial environment and a significant number of people (and money) is required in order to change trends seen in these areas.  If we were to view commodities from a purely fundamental perspective, it might be difficult to see the point at which the new trend is beginning.  But when we deconstruct the charts themselves, it starts to become much easier to spot the trading signals as they arise.

In the most basic sense, breakout traders are looking for a period of indecision and sideways trading in the market.  This essentially means that most traders are unclear on their stance and are not currently prepared to establish a position to buy or sell the asset.  Once these conditions change, it is generally a good idea to side with the direction of the trading range breakout.  This does not mean that every breakout trade is successful.  But it does mean that the majority of the market is now in agreement with your positioning and that further price follow-through is the most likely outcome.

As we can see in the example above, we can see that any commodities trader spotting the bearish breakout signal and committing to a short position would have captured significant profits.  This is because the momentum required to break the initial trading range was large enough to propel prices much lower in the coming days and weeks.  In this way, breakout strategies can help traders view the market in a more objective fashion and capitalize on emerging trends as they are still in their earliest stages.


Fibonacci Analysis in Commodities

Commodities traders that are still in the early phases of their careers tend to have a difficult time with some of the terminology that is regularly used in the financial markets.  This is perhaps most true in the technical analysis sphere, which has its own lexicon that might seem daunting at first.  But once we understand the basic concepts underlying the terms, it starts to become much easier to grasp the new vocabulary.

One of these words is Fibonacci, which is a way of analyzing price trends and deconstructing them into their component parts.  Fibonacci analysis can be a highly useful addition to a broader trading strategy, and can help investors view a the price activity in a commodity in a more objective way.  Many traders will argue that Fibonacci analysis should not be used as the basis for an entire trading idea on its own.  But when Fibonacci is employed as part of a broader technical analysis strategy it becomes much easier to spot high probability trading opportunities.  Here, we will discuss the ways traders conduct Fibonacci analysis when trading in the commodities markets.

Fibonacci Defined

Fibonacci analysis is based on the Fibonacci sequence, which is a series of numbers developed by a mathematician in the 13th century.  In modern times, the ratios found in this series of numbers are used to view movements in price trends in a more objective way.  The critical percentages used in FIbonacci Analysis are: 38.2%, 50%, and 61.8%.   These percentages can be applied to both downtrends and uptrends.  A visual representation for both structures can be found in the graphics below:

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Source: Wikipedia

First, let’s take a look at the uptrend structure.  Prices start at point A, and then rally sharply to point B.  But, eventually, strong moves like this need to correct themselves in order to bring markets back closer to their historical averages.  In Fibonacci analysis, these corrective moves are retracements.  In the graphics above, these retracements are marked at points C, D, and E.  Point C marks the 38.2% retracement of the move from point A to point B.  Once the 38.2% retracement is hit, it essentially shows that 38.2% of the original rally have been retraced (corrected).  In an uptrend, this price zone would be viewed as support.  This is because most of the market’s momentum in in the upward direction and the following retracement is now giving investors the opportunity to re-enter the uptrend at lower prices.

Of course, there is no guarantee that markets will reverse at the 38.2% Fibonacci retracement and then resume the previously uptrend.  If prices fall further, the price zones associated with the 50% and 61.8% Fibonacci retracements would next be viewed as support levels.  Commodities traders could make the decision to buy the asset in either or both of these areas as there is an increased chance that market participants will capitalize on the lower levels.  If the uptrend resumes, the trades will reach profitability as the positive momentum reasserts itself.

The same rules apply for downtrends, only in reverse.  The only different in the bearish scenario is that each of the retracement levels will be viewed as resistance zones that can be used to start establishing sell positions.  So, if we look at the structural example shown above, commodities traders could consider selling the market once prices rise to the 38.2%, 50%, or 61.8% Fibonacci retracement.  In these ways, it should be clear that Fibonacci analysis can be applied to all market condition, no matter which direction characterizes the dominant trend.

Real-Time Examples

Now that we understand the basic structure of Fibonacci analysis, it is time to get a visual perspective on how these strategies appear on real-time charts.  In the example below, we have established price activity in oil:

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Chart Source: Metatrader

Looking at this chart, a few things should be clear.  First, is that prices have established a clear uptrend and that commodities traders should be looking for corrective opportunities to buy into the positive momentum.  This is where Fibonacci analysis comes in.  Consider the chart below:

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Chart Source: Metatrader

Here, we can see the same price activity with the Fibonacci study added.  The solid grey line marks our initial price moved, the AB line shown in the uptrend structure.  This line marks the basis from which all of the later analysis will be conducted.  Prices hit highs at point B, and then markets start to retrace.

In this example, prices fall to the 61.8% retracement which then becomes support:

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Chart Source: Metatrader

Here, we can see that Fibonacci analysis sends a “buy signal” to the markets as prices make a deep retracement of 61.8%.  This Fib zone then acts as support, helping inspire traders to start buying oil.  Prices are relatively cheap here, even though we are still in the midst of a strong uptrend.  Scenarios like this mark excellent buying opportunities, as the Fibonacci offers the dual benefit of a supportive uptrend and low prices.

As we can see here, markets are able to make a significant rally after these minor declines: 

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Chart Source: Metatrader

As we can see here, markets are able to make a significant rally after these minor declines.  All of these gains could have been captured by traders that were able to identify the FIbonacci support zone and buy oil as it was making slow declines.  In these ways, commodities traders are able to use Fibonacci analysis in active trading.


The Commodity Channel Index (CCI)

Now that financial trading has become largely reliant on computers, we have seen steady increases in the number of investors practicing technical analysis.  When commodities investors use price chart analysis to identify trading opportunities and establish market positions, there is a wide variety of tools that might be employed.  One of these tools that was specifically designed for the commodities market is the Commodity Channel Index, or CCI.

The CCI is a powerful technical indicator that can send buy and sell signals for any commonly traded commodity.  But what exactly is the Commodity Channel Index, and what do its signals tell us about the market?  Specifically, the CCI is a chart indicator that assesses market prices and spots instances where an old market trend might or ending — or where a new market trend might be emerging.  This information can be incredibly useful for those making a decision to buy or sell a commodity. Here, we will look at some examples that show how the CCI indicator accomplishes these tasks.

The Basics of CCI

The CCI indicator is placed below the price action on your chart, and is plotted using a scale of -100 to 0 to +100.  We can see an example of the CCI shown in blue on the gold chart below:

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Chart Source: Metatrader

To the right of the indicator, we can see the CCI scale, shown in the red circle.  This highlighted area marks a significant region of the indicator because the readings shown here generate the CCI’s buy and sell signals.

Indicator readings that fall below the -100 mark as said to be oversold.  This essentially means that prices have fallen outside of the standard deviation, and that a rally is becoming increasingly likely.  In financial markets, “standard deviation” is simply a fancy way of describing the average range of price fluctuation.  Once prices move outside of this range, there is a high probability that markets will soon correct back toward their average prices.

When we are in the oversold region, this means prices are likely to start rising.  When we are in the overbought region (+100), it means that prices are likely to start falling.  Oversold readings are equivalent to buy signals, because these are indicator points that suggest upward price movements have become more likely.  Overbought readings are equivalent to sell signals, because these are indicator points that suggest downward price movements have become more likely.  Overbought and oversold readings are marked in the chart below:

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Chart Source: Metatrader

Each of these areas marks a significant signal that is being sent by the CCI, and commodities traders are able to use this information in order to start establishing new positions in the market.

Say, for instance, that you believe gold prices will start rising in the future because gold miners have limited their production output.  Having a strong basis to start buying gold is great — but ultimately you will need to decide on an exact price level to start building your positions.  If you see that gold prices have fallen into oversold territory, you would then have a technical analysis argument to support your theory for higher gold prices.  This would strongly turn the odds into your favor and give you a relatively specific price entry level to start buying gold.  As in the chart above, the first oversold reading comes very early in the significant rally that follows.  Commodities traders that spotted this signal could have entered into long positions in gold and captured substantial profits.

Beginning and Ending Trends

Another way that commodities investors utilize the CCI is to find areas where an old trend is ending — or where a new trend is beginning.  This, again, is highly valuable information because proper trend assessment is what allows commodities traders to truly “buy low, and sell high.”

If you are able to spot the signals and see that a long-term uptrend is ending, you can start to establish short positions while prices are still elevated.  At the very least, prices should eventually move back lower to their historical averages — and the difference will be captured as profit in your position.  The same can be said for bearish downtrends that have forced prices into oversold territory (in signals that can be used in establishing long positions for that asset).

Consider the following chart in oil:

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Chart Source: Metatrader

In this example, we can see that prices start by moving lower in a forceful manner.  The CCI reading then become oversold, as market prices have exceeded the standard deviation and move too far away from the historical averages.  In essence, prices have become too cheap — and a corrective rebound has become increasingly likely.  The CCI sends multiple buy signals, all of which are later confirmed by upward movements in price.

To be sure, some of these buy signals would have resulted in more profit than others.  But it should be obvious from this example that these buy signals were at least accurate in identifying the price direction and the end of the initial downtrend — and this in itself is enough to turn the odds in your favor when placing trades in the commodities market.  In these ways, the CCI indicator provides some highly valuable information for those looking to add technical analysis methods to a broader commodities trading strategy.



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