TECHNICAL ANALYSIS - BASIC INDICATORS
Technical and fundamental analysis are the primary methods used to analyze commodity markets when making trading decisions. Both are extremely important aspects of investing and new investors should take the time to learn and understand market forces before attempting to trade commodity markets.
Fundamental analysis in the commodity market focuses on economic indicators, asset markets and political developments that determine forces of supply and demand as it pertains to commodity valuation. Economic indicators include data and economic releases/reports, inflation, unemployment, money supply and productivity. Asset markets include stocks, bonds and real estate. Political developments include any financial, social or political event that can impact the level of confidence in a nation’s government (and ultimately the confidence in that nation's currency and commodity markets).
Technical analysis focuses more on price action and volume to forecast future price direction. Analytic studies and indicators based on mathematical formulas are used to analyze historical pricing data to attempt to predict future price direction. Below are the basics of common technical analysis indicators/studies. We will be adding more studies shortly, so please be sure to bookmark this page and check back soon.
*This webpage is not intended to be all-inclusive, and provides only a basic overview of technical analysis and summaries of a few of the more common technical indicators.
Click on the links below for more information:
| Bollinger Bands | |
| Moving Average Convergence/Divergence (MACD) | |
| Moving Average (MA) | |
| Relative Strength Index (RSI) | |
| Slow Stochastic (SSTO) |
Bollinger Bands
Developed by John Bollinger, Bollinger Bands are essentially a trading envelope consisting of two indicators plotted at an interval above and below a moving average indicator. The upper band is typically two standard deviations added to the moving average and the lower band is two standard deviations subtracted from the moving average. Bollinger Bands allow traders to compare volatility and relative prices levels over a period of time. Traders generally use Bollinger Bands to determine when prices are at overbought and oversold levels. Typically, the bands widen as volatility increases and the bands narrow as volatility decreases.
Parameters:
-
Period (20)
- the number of periods used to calculate the study. John Bollinger has stated
that periods less than ten days do not work well for Bollinger Bands. The
recommended period for most applications is 20 or 21 days.
-
Standard Deviation (2)
MACD
The Moving Average Convergence/Divergence study (MACD) was developed by Gerald Appel. In the opinion of CFOS/FX, the MACD is one of the simplest and most reliable indicators in use. The MACD uses moving averages to construct an oscillator and the trading rules are simple. You buy when the oscillator crosses above the slower moving average and you sell when the oscillator crosses below the slower moving average. In addition, divergence can be indicated with the MACD.
You can also use this study in conjunction with long term charts. For example,
you use a longer term chart such as a weekly or monthly chart along with the
corresponding intraday or daily chart and you display the study on the long term
chart. If the MACD on the longer term chart is bullish you should be cautious
initiating short positions since you are trading against the longer term trend.
Parameters:
-
First (12)
- the number of bars used to calculate the first Exponential Moving Average.
-
Second (26)
Difference (9)
Moving Average (MA)
Moving averages are one of the most popular
technical tools used by traders and as building blocks for other technical
indicators and overlays. They smooth the normal fluctuations of the data making
it easier to spot or follow the trend.
A Simple Moving Average (SMA) computes the average price (usually the closing
price) over a number of periods. An Exponential Moving Average (EMA) gives more
influence to the most recent prices in computing the average and thus is closer
to the actual price that the SMA typically is. The SMA also lags more than the
EMA and indicates change in trends a little later.
Moving averages are commonly used in crossover susyems. The normal moving
average crossover buy/sell signals are as follows. A buy signal is triggered
when the short and intermediate term averages cross from below to above the
longer term average. Conversely, a sell signal is issued when the short and
intermediate term averages cross from above to below the longer term average.
The crossover approach can be employed with only two moving averages, but many
chart technicians suggest longer term averages when trading only two moving
averages in a crossover system. Price can also be used to trigger buy/sell
signals. A buy signal is triggered when price crosses from below to above a
moving average and a sell signal is triggered when price crosses from above to
below a moving average.
Parameters:
-
Period1 (4)
- the number of bars used to calculate the first moving average.
-
Period2 (9)
Period3 (18)
RSI
The RSI is another popular and extremely useful
J. Welles Wilder trading tool. The purpose of the RSI is to compare the
underlying strength and weakness and output a number between 0 and 100. A high
RSI, above 70, suggests an overbought or weakening bull market. Conversely, a
low RSI, below 30, implies an oversold market or dying bear market.
While you can use the RSI as an overbought and oversold indicator, it works best
when divergence occurs between the RSI and market prices. For example, the
market makes new lows after a bear market pullback, but the RSI fails to exceed
its previous lows. Another example of divergence is when prices continue to move
higher while the RSI fails to move higher during the same time period. Although
divergence may occur in a short time frame, true divergence usually requires a
longer time frame of 20 to 60 periods.
Simply selling when the RSI is above 70 or buying when the RSI is below 30 is
not recommended. A move to those levels is a signal that the top or bottom may
be a near but it certainly does not indicate a top or a bottom.
Parameters:
-
Period (14)
- the number of bars used to calculate the study.
-
Slow Stochastic (SSTO)
The stochastic indicator was developed Dr. George
C. Lane in the late 1950s. The stochastic study is an oscillator designed to
indicate oversold and overbought market conditions. The basic premise of this
study is as follows: Closing levels that are consistently near the top of the
range indicate accumulation (buying pressure) and those near the bottom of the
range indicate distribution (selling pressure).
Some technical analysts prefer the slow stochastic rather than the normal
stochastic. The slow stochastic is simply the normal stochastic smoothed via a
moving average technique.
The slow stochastic, like the normal stochastic study, generates two lines. They
are %K and %D. The stochastic has overbought and oversold zones. Dr. Lane
suggests using 80 as the overbought zone and 20 as the oversold zone. Other
technicians prefer 75 and 25.
Dr. Lane also contends the most important signal is divergence between %D and
the price. Divergence is defined as the process where the stochastic %D line
makes a series of lower highs while price makes a series of higher highs. This
signals an overbought market. An oversold market exhibits a series of lower lows
while the %D makes a series of higher lows.
Once the oscillator reaches overbought levels, wait for a negative divergence to
develop and then a cross below 80. This usually requires a double dip below 80
and the second dip results in the sell signal. For a buy signal, wait for a
positive divergence to develop after the indicator moves below 20. This will
usually require a trader to disregard the first break above 20. After the
positive divergence forms, the second break above 20 confirms the divergence and
a buy signal is given
Parameters:
-
Overall Period (14)
- the number of bars used to determine the highest high and lowest low.
%K MA Period (3)
%D MA Period (3)
AdditionalLinePeriod (3) - the number of bars used to determine an additional Moving Average on the Stochastic.