Welcome to the Friday edition of FutureSource.com's Fast Break.
Today's author is Jeffrey S. Friedman. Jeffrey is a Senior Market Strategist with Lind-Waldock, a Division of Refco, LLC. Jeff has been in the futures industry for over two decades, having begun his career as a clerk at the Chicago Board of Trade. [more] |
Technical Analysis 101
There are two major types of analysis typically used to predict the performance of commodity futures - fundamental and technical. Fundamental analysis examines the supply and demand factors that influence a market's price and technical analysis is the study of price and price behavior.
Today, the world of technical analysis is huge. There are literally hundreds of different patterns and indicators that traders claim to have success with. In this article, I'll introduce you to a few very basic types of price charts and technical analysis tools.
What is Technical Analysis?
Using charts as a primary tool, traders who employ technical analysis look for peaks, bottoms, trends, patterns and other factors that affect commodity futures' price movement, which they then use to make buy or sell decisions. Today's technical analysis includes such principles as the trending nature of prices, prices discounting all known information, moving averages, volume mirroring changes in price, and the identification of support and resistance levels.
The price of a commodity represents a consensus between buyers and sellers of all the information about that commodity at any given point in time. It is the price at which one person agrees to buy and another agrees to sell. The price at which a trader is willing to buy or sell depends primarily on expectations. If he expects the commodity's price to rise, he will buy it; if he expects the price to fall, he will sell it.
Technical analysis reflects on a commodity's historical prices in an effort to determine probable future prices. This is done by comparing current price action (i.e., current expectations) with comparable historical price action in order to predict a reasonable outcome. The technician might observe that history repeats itself in price behavior because human behavior repeats itself.
Technical analysis is a method of evaluating commodities by analyzing statistics generated by market activity, past prices, indicators and volume. Technical analysts do not attempt to measure a commodity's intrinsic value; instead they look for patterns and indicators on commodity charts that will determine a future performance. |
A
Word From a Fast Break Sponsor
Advertise With Us
Two Basic Charts Types
Bar charts are some of the most popular charts used in technical analysis. They display the open, close, daily high and daily low for whatever time period you want to use. Bar charts can be used for any time frame. The daily chart, which is the most popular time period, is often used to study price trends for the most recent six months. For longer-range trend analysis going back five or 10 years, weekly and monthly charts are more useful. Intraday charts can be used by day traders to plot prices for periods as brief as one minute. |
| Each time period is a vertical line, with the top of the vertical line indicating the highest price the commodity traded at during the time period, and the bottom representing the lowest price. (See graph #1 above.) The closing price is displayed on the right side of the bar and the opening price is shown on the left side of the bar. A single bar represents one time period of trading. The advantage of using a bar chart over a straight-line graph is that it shows the high, low, open and close for each particular time period (i.e., usually daily). |
Candlestick charts, which have been around for hundreds of years, are similar to bar charts in that they also display the open, close, daily high and daily low. The primary difference is that if the closing price is above the opening price, the body is usually clear, white or green. If the closing price is below the opening price, the body is usually solid, black or red. (See graph #2 above.)
Technical Indicators You Can Use
A moving average is one of the easiest indicators to understand. For example, to calculate the 50-day moving average, you would add up the closing prices from the past 50 days and divide them by 50. Because prices are constantly changing, the moving average will move as well. Moving averages are most often compared or used in conjunction with other indicators such as Moving Average Convergence Divergence or the Relative Strength Index discussed below.
While you can choose any time period you wish, the most commonly used moving averages are of 10, 20, 40, and 50 days. Each moving average provides a different interpretation of what the commodity price will do. There is no one right time frame to use. The longer the time spans, the less sensitive the moving average will be to daily price changes. Moving averages are used to emphasize the direction of a trend and smooth out price and volume fluctuations (or "noise") that can confuse interpretation. Typically, when the price moves below its moving average it is a bad sign because the commodity is moving on a negative trend.
|
A
Word From a Fast Break Sponsor
Advertise With Us
The Moving Average Convergence Divergence (MACD) is one of the simplest and most reliable indicators available. MACD uses moving averages, which are lagging indicators, to include some trend-following characteristics. These lagging indicators are turned into a momentum oscillator (a measure of how much prices have changed over a given time period) by subtracting the longer moving average from the shorter moving average. The resulting plot forms a line that oscillates above and below zero, without any upper or lower limits. MACD is a centered oscillator, which fluctuates above or below a center point, and the guidelines for using centered oscillators apply.
When we talk about the strength of a commodity futures contract there are a few different interpretations, one of which is the Relative Strength Index (RSI). The RSI compares the number of days that the contract finishes up with the number of days the contract finishes down. This indicator is a big tool in momentum trading.
The RSI ranges from 0 to 100. A commodity price is considered overbought around the 70 level and you should consider selling. This number is not written in stone. In a bull market some believe that 80 is a better level to indicate an overbought price, since prices often trade at higher valuations during bull markets. Likewise, if the RSI approaches 30, price is considered oversold and you should consider buying. Again, make the adjustment to 20 in a bear market.
The shorter the number of days used, the more volatile the RSI is and the more often it will hit extremes. A longer term RSI is more rolling, fluctuating a lot less. Different commodities and futures contracts have varying threshold levels when it comes to the RSI. Prices in some futures contracts will go as high as 75-80 before dropping back and others have a tough time breaking past 70.
Using Support and Resistance
Support and resistance are price levels at which movement should stop and reverse direction. Think of support and resistance as levels that act as a floor or a ceiling to future price movements. Support is a price level below the current market price, at which buying interest should be able to overcome selling pressure and thus keep the price from going any lower. Resistance is a price level above the current market price, at which selling pressure should be strong enough to overcome buying pressure and thus keep the price from going any higher. (See graph #2 above.)
One of two things can happen when a futures contract price approaches a support or resistance level. The first is, it can act as a reversal point, or in other words, when the futures price drops to a support level, it will go back up. The other possibility is that support and resistance levels can reverse roles once they are penetrated. For example, when the market price falls below a support level, that former support level then becomes a resistance level when the market later trades back up to that level.
|
A
Word From a Fast Break Sponsor
Advertise With Us
Popular Charting Patterns
Many of us believe that history repeats itself. Using successful and proven price patterns from price charts is a method widely used by technical analysts. Here are just a few examples:
Cup and Handle. This is a pattern on a bar chart that can be as short as seven days or as long as 65 days. The cup is in the shape of a U. The handle has a slight downward drift. The right hand side of the pattern has low trading volume. As the price comes up to test the old highs, the price will incur selling pressure by the people who bought at or near the old high. This selling pressure will make the price trade sideways with a tendency towards a downtrend for four to 30 days, and then it may take off. It looks like a pot with handle.
Head and Shoulder. This chart formation that resembles an "M" in which a price rises to a peak and then declines, then rises above the former peak and again declines, and then rises again, but not to the second peak and again declines. The first and third peaks are shoulders, and the second peak forms the head. This pattern is considered a very bearish indicator.
Double Bottom. A double bottom occurs when a price drops to a similar price level twice within a few weeks or months producing a pattern that resembles a "W." You should buy when the price passes the highest point in the handle. In a perfect double bottom, the second decline should normally go slightly lower than the first decline to create a shakeout of jittery traders. The middle point of the "W" should not go into new high ground. This can be a very bullish indicator.
There are entire volumes of textbooks written on technical analysis. Technical analysis is one of those fields where everyone has a different theory on what works and what doesn't. If I may leave you with one more suggestion, it would be to back test whatever strategy you decide to pursue. Back testing means looking back at several years' worth of charts to see how a particular futures contract reacts. Different commodity futures do different things, so be sure to do your homework first or contact me and I'll be happy to help you with your technical analysis.
|
About
the Author
Jeffrey S. Friedman is a Senior Market Strategist with Lind-Waldock, a Division of Refco, LLC. Jeff has been in the futures industry for over two decades, having begun his career as a clerk at the Chicago Board of Trade. In 1982, he became a member of the CBOT where he worked both as a local and as a floor broker, trading for his own account and filling customer orders. Before joining Lind-Waldock in 2000, Jeff was an AP of two other Chicago-based brokerage firms.
Jeff trades a wide range of markets, including financial instruments, energies, metals, grains and softs. He uses a combination of fundamental and technical approaches, depending upon the market. In this article, Jeff explains the basics of technical analysis. Jeff can be reached at 866-231-7811 or 312-788-2860, or by email at jfriedman@lind-waldock.com
|
For
Our Fast Break Readers
Disclaimer
The Commodity Futures Trading Commission has asked us to also advise you that trading futures is not without risk. While there is opportunity for incredible wealth building, there is also the risk of losing even more than you invested. Of course, that's not unlike most other businesses. But informed traders are the best traders! Opinions expressed by Fast Break authors are not those of FutureSource.
|
Looking For a Broker?
Did you know that FutureSource has a Broker Search Page, designed to connect you to the broker that best suits your needs?
Check it out!
|
|
|
