Lesson 9: How you can use technical and positional analysis to your advantage

In yesterday’s lesson you learnt more about some of the main ways that you can either invest in commodities or to speculate on future price moves – both up and down.

In this lesson you will learn why it’s important to be aware of the objectives of all market participants in commodity markets and why using methods like technical and positioning analysis offer very good insights into whose doing what, and what happens when they do too much of it and how it then relates to other factors like the price and fundamentals.

Technical analysis

Technical analysis involves analysing past price patterns, trends and volume in order to try and determine future price movements.

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 indicators are further split into oscillators and trend following indicators.

Traders need to first identify the price characteristics of a market – ie, 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 tend to be misleading in a trending market.

One of the simplest and most widely used indicators in technical analysis is the moving average (MA), which is the average price for a commodity over a specified period. For example, a 200-day MA will be the average of the closing prices over the last 200 days, including the current period. If the price crosses over the 200-day MA combined with an increase in trading volume then this is suggestive of a sustained move in the same direction.

The Relative Strength Index (RSI) is also a popular and 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.

Positional analysis

Positioning analysis involves understanding the actions of speculators and physical market participants.

The Commitment of Traders report is issued by the US Commodity Futures Trading Commission (CFTC). It is released every Friday at 15:30 Eastern time with data from the week ending the previous Tuesday. It records the actions of participants in commodity futures markets and breaks down their activity into four categories depending on their role in the market.

The most important category, ‘Managed Money’ includes hedge funds, together with pension funds, commodity trading advisers, and any other organization managing or conducting futures trading on behalf of clients.

Money managers have to close out their positions at some point. So, when you see a very large short position that means very simply that they are going to have to close that position out.

And if you see that in the context of a very low price suggesting that those money managers have made some money building up that short position and prices have fallen, that can be a very interesting buying opportunity as there is a high risk that those prices move higher as a function of short covering (buying back futures contracts previously sold, in order to lock-in a profit or minimise losses).

Blended approach

A blend of different approaches is essential. Now with information being much more accessible, a more balanced exposure to different ways of analysing commodity markets is very sensible.

The challenge lies in knowing when you need to look at fundamentals, when technical analysis is important and when the slightly more esoteric things like sentiment and behavioural patterns and positioning can help.

I hope you found this lesson on technical and positional analysis interesting.

In the next lesson we will focus on the pitfalls that you need to watch out for.

Go to lesson 10