Recommended Technical Indicators for Commodity Investing
The goal of any trader or investor is to make as much profit as possible. To achieve this, traders go long or short on certain assets, which includes: commodities, currencies, stocks, ETFs, and derivatives, among others. For day traders, profits are derived from the most liquid markets such as currencies and commodities. Some day traders combine these assets while some focus on single instruments. In my previous article, I explained the reasons why one should narrow his focus on a few instruments as possible. By focusing on a few instruments, a trader is able to have in-depth understanding of the market and its movements.
Commodity investing involves trading basic commodities such as gold, corn, oil, silver, palladium, and lead among others. In the past, one had to physically own the commodities. This has been overshadowed by technology which allows one to trade commodities without actually owning them. It is also possible to buy and sell a commodity within seconds. The Bloomberg Commodity Index (BCI) provides accurate tracking of the 20 traded commodities.
This week, the BCI traded at the lowest levels with gold trading at a 5 year low. Silver and other commodities also traded in the lowest multiples. This was impacted by a number of factors such as the strengthening dollar and the weakening economy in China. In addition, the fears of a rate increase in the United States fuelled the sell-off.
These price movements were a bad news for the commodity bulls but a good news for day traders who place more than one trade per day. Day traders make money regardless of the direction the chart moves. Technical indicators play a very important role in their analysis.
To identify a trend, moving averages (MA) is one of the most commonly used indicators in the market. The indicator reflects the average price of an asset over a specified period of time. For instance, a 10-period MA represents the average of the closing price of the instrument over the last 5 days. For day traders who use intraday, the calculation of the MA is based on the current price, rather than the closing price. In this, when the price crosses above the MA, it is usually a signal to buy while when the MA crosses the chart below, a sell signal is indicated. For day traders, this is usually a simple way of identifying the buy, sell or hold prices for commodities. However, the strategy is not ideal for a ranging market where prices move back and forth. In addition, a steeper MA is an indication that the momentum is backing the trend. On the other hand, a flattening MA is a warning of a reversal.
Moving Average Convergence Divergence (MACD)
Developed by Gerald Appel, MACD is a momentum indicator which leverages the power of Moving Average. The indicator is calculated as a 12-day Exponential Moving Averages) minus the 26-day EMA. A trader should look at the signal line which is the 9-day EMA of the MACD because it helps to identify the turns and divergences. In this, a buy signal of a commodity or currency pair is generated when the MACD value is positive because the shorter EMA is higher than the longer period. A sell signal is indicated by a negative MACD value. In addition, when a negative MACD value decreases, it is an indication that the down trend is losing its momentum and vice versa.
Relative Strength Index (RSI)
RSI is another common indicator used for technical analysis. The indicator checks the momentum of the market by identifying the overbought or oversold levels on a scale of 0 to 100. A level above 70 indicates an overbought position while a level below 30 indicates an oversold position. The key issue when using the RSI is to set the trading cycles accurately. While many experts believe in a 14-day RSI, for day traders, a short cycle of 9 days is appropriate. In addition, it is important to be aware of a trending and a ranging market. RSI is never appropriate for ranging markets. Identifying a divergence is also very important. Divergence happens when an instrument is making a new high and a reversal happens when the RSI fails to move beyond the previous high.
For commodity investors, it is also very important to have information about the economic conditions and the economic data before placing any trade. This will help you understand when to place a trade, when to hold and when to sell. When dealing with technical indicators, I recommend that you first understand each one of them to avoid false signals.