Various analysis tools used to predict the price movements in commodity futures trading

Various analysis tools used to predict the price movements in commodity futures trading

In order to predict the future price of a commodity, the various analyses, tools are used. In order to make the daily or regular predictions, two important analyses made are:

Technical Analysis

Fundamental Analysis

TECHNICAL ANALYSIS

Technical analysis refers to the process of analyzing the market with the help of technical tools, which includes charts, and henceforth makes future predictions of the prices. The only important factor for analyzing the market is price action.

Bar Chart

A Bar Chart is one of the most widely used charts. The market movement is reduced on a daily basis as a vertical line between the high and low; the opening level being indicated as a ‘horizontal dash to the left’, the closing level being indicated as a ‘horizontal dash to the right’. As well as a daily record, similar charts can be drawn for weekly or monthly price ranges. Although bar charts are the most popular for technical analysts, their minor limitation is that they do not show how the market acted during the trading day.

A line chart is the simplest chart, and generally drawn by the non technical investor interested in getting quick visual impression of the general movement of the market. Normally closing prices are used and joined to form a line chart. They are not really adequate for market movement interpretation, but can give a very good indication as to what the market has been doing over a longer time scale, up to 10 to 20 years.

Moving averages

Moving averages are used to iron out some of the more volatile short-term movements, and can give better buy and sell signals, than just by looking at a daily high-low-close pattern. For instance, a 20-day moving average refers to the average price, of the previous 20 days. In the above chart the red line is the 20-day average. The green line is the 50-day average and the yellow line is the 100 day average.

Gaps

A Gap is formed when one day’s trading movement does not overlap the range of the previous day. This may be caused by the market opening sharply highly or lower than the previous days close, as a result of important overnight news. Strong movements in overseas markets influencing our market or interest, or quite simply because the market has started to develop a strong momentum of its own.

Break away gap

This usually occurs soon after a new trend has been established as large numbers of new trend has been established, as large numbers of new investors suddenly want to join the action. It is often regarded as a confirmation that a new trend is well established.

FUNDAMENTAL ANALYSIS

Fundamental analysis is the study of supply and demand. The cause and effect of price movement is explained by supply and demand. A good fundamentalist will be able to forecast a major price move well in advance of the technician.

E.g. if there is a drought in Brazil during the flowering phase of soybean plant one can rationally explain why bean prices are rising.

There are various factors affecting the fundamentals of different commodities.

They are

Fundamentals affecting Agriculture Commodities

a) Supply

The supply of a grain will depend on

i) Beginning stocks

 This is what the government says, it will carryover from the previous year

ii) Production

This is the crop estimate for the current year.

iii) Imports

This includes the commodities imported from different countries.

iv) Total supply

This is the beginning stocks+production+imports

b) Demand

i) Crush

This is the domestic demand by the crushers who buy new soybeans. And crush them into the products, meal and oil.

ii) Exports

This refers to the quantity of different commodities demanded by foreign countries.

c) Ending carryover stocks

Total supply minus total demand= the carryover, ending stocks

d) Weather

Weather is the single most important factor, which affects the process of all types of grains. If there is flood drought, it will shoot up the price, due to increase in demand.

e) Seasonality

All other factors remaining equal, the grains and oil seeds do exhibit certain seasonal tendencies.

Metals fundamentals

Metals include

Precious metals

Industrial metals

Precious metals

The precious metals include gold, silver, and platinum. Their fundamentals are

i) Silver

Since much of the new production of silver comes as a by-product of the 3 metals (copper, zinc, lead), if the price of the 3 is depressed and production is curtailed, silver output will suffer as well. The reverse is also true.

ii) Platinum

The demand for platinum is somewhat dependent on the health of the automotive, electrical, dental, medical, chemical, and petroleum industries (where it is used as a catalyst.)

Industrial metals

These include copper, palladium. Their fundamentals are

i) Economic activity

For any metal, industrialized demand is the key. If there is the threat of an economic slow down, this will be reflected in lower prices.

ii) LME stocks

Everyday the London Metal Exchange releases its widely watched stocks report, where, it lists the stocks in the exchange approved warehouses for aluminum, copper, zinc, tin, lead.

iii) Mining strikes and production problems

iv) War

Copper in particular has been called the ‘war’ metal. Demand traditionally soars for all the industry al metals in times of increased defense spending.

v) Inflation

The industrial metals have been at times been called the ‘poor man’s gold’ and will heat up in an inflationary environment.

Analysis

Predictions in the commodity futures trading can be made through 2 tools i.e. fundamental analysis and technical analysis. Fundamental analysis seeks to protect the market by making use of the demand and supply factors. It helps to explain what the general tendency in the market is. Technical analysis is the process of using all kinds of tools and charts, in order to make predictions, it helps to explain exactly at which point to enter a position or helps to explain at what point will be the trend reversal.

Interpretation

From the above analysis, it can be concluded that, by making use of both the fundamental and technical analysis efficiently, and henceforth take a favorable position in the market and thus benefit from the price movements.