For many farmers, picking price points and making projections are the most valuable things analysts do.
After all, what is the point of analysis if it doesn’t help a farmer determine when and at what price to sell his crops?
Although many farmers only want to hear an analyst’s price projection and don’t care how he came up with it, there are valuable lessons to learn from looking at the process. That’s because some analysis doesn’t require complicated formulas and supercomputers, but can be done with pen, paper and some simple calculations.
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The commodity funds that dominate the market are often secretive about their analysis and the sexiest price analysis is often highly technical. But one well-known analyst sticks with his tried-and-true methods, even if they are now considered old hat.
Recently, Darin Newsom of DTN apologized in the midst of his 2008 market outlook for not basing his projections on Fibonacci numbers and the Fibonacci ratio, which are all the rage among analysts these days. Instead he was sticking with Dow ratios, which he began using because they were easy.
“The rationale is somewhat crazy,” Newsom said.
But Dow ratios also seem to be right, which is why he has stuck with them for years.
Newsom began using Dow numbers in the 1980s, when he was doing analysis for grain trading and analysis companies. Basic Dow theory, which is more than a century old, says that when prices break out of a trend, they tend to go the other direction by relatively predictable amounts, usually by one-third, one-half or two-thirds.
Those are easy, convenient and, surprising to Newsom when he started, relatively accurate measures of a likely price movement. He was doing what was common in those days, making hand-drawn charts of wheat price movements, when he noticed that after wheat price peaks, prices tended to fall back by 33, 50 or 67 percent, just as Charles Dow had suggested.
By measuring the “retracement” from the previous rise, Newsom found he got a good read on whether a long-term upward trend would resume, which was more likely if the retracement was 33 percent. A 67 percent fallback meant the crop was unlikely to resume beyond the previous peak.
He was happy that Dow numbers worked, because figuring out Fibonacci-based retracements would have been far more difficult on hand-drawn charts, considering that it relies on numbers like 0.618 and 1.618.
In reality, they aren’t actually that different from the Dow ratios, which is why, at a basic level of analysis, they can often be interchangable. Multiplying something by 1.618 is like adding almost two-thirds to it, and a one-third retracement in Dow terms is similar to multiplying it by 0.618.
There’s no Fibonacci equivalent for the 50 percent measure, but that’s life.
Newsom, like most analysts, doesn’t claim to understand why prices tend to move by these magical amounts. There are lots of theories, including the belief that because so many people use these measures they become self-fulfilling prophecies.
But he knows that in coming up with price forecasts, he’s comfortable using the Dow measures, even if that makes him uncool.
