Technical analysis terms can seem weird and silly – until they explain why you lost a bunch of money.
Then they assume more relevance.
That’s the situation that confronted producers on June 19, when crop prices plunged after days of warnings from several sources about the market being overbought.
“Black Tuesday on Fund Selling, Rain, Overbought Condition,” was agricultural market newsletter Agriline’s headline after the sell-off. The November canola contract lost $10.80 a tonne that day and corn was down the 20 cent limit, beginning a multiweek drop.
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The newsletter, in its explanation of traders’ reasoning about bidding down prices, described changes in the relative strength index (RSI) that occurred between the peak and decline.
“The sell-off more or less cured overbought conditions in virtually all markets,” Agriline said.
“The 14 day relative strength index for canola was at 52, down from 65 over the past week. Winnipeg wheat 58 (73), barley 71 (89).”
If all you wanted was an explanation for the plunge, that was probably enough. But if you wanted to understand what happened, but haven’t studied technical analysis, an explanation like the one above – which is typical of many market commentary services – was probably bewildering and frustrating.
However, it’s a great introduction to the concept of overbought and oversold. Many market analysts consider “momentum indicators” to be key signposts to market direction.
“They can be very reliable,” said David Drozd, the technical analyst who runs the market forecasting firm Ag-Chieve in Winnipeg.
“They work quite well.”
Farm marketing adviser Brenda Tjaden Lepp also believes in using momentum indicators such as the RSI to trigger sales.
“Frankly, I don’t have a clue which is the best indicator … but if I can get four or five to line up and say the same thing, then I just have more confidence in the decision,” she said.
Momentum indicators include the RSI, fast and slow stochastics, moving averages, the moving average convergence/divergence (MACD), rate of change (ROC) and directional movement index.
They are different from the form of technical analysis that looks only at raw prices. Momentum indicators are designed to reveal whether prices are trending higher or lower, the strength of the trend and whether it has become out of whack – which is referred to as oversold or overbought.
You can find them on most good market websites, such as www.futures.tradingcharts.ca. At that site you need to bring up the commodity charts page, pick a commodity and contract and select the Daily Java Chart button.
A string of words appears at the top of the chart. If you click on “studies” you are offered a list of various momentum tools.
Normally the momentum indicators appear as lines in little charts that lie underneath the larger commodity price charts.
The point of the momentum indicators is that they signal a possible price reversal before it occurs and reveal different structures than price chart formations.
The RSI shows whether the price for a particular commodity is closing more up or down. Stochastics reveal whether something is closing strongly or weakly. The ROC reveals the strength of price increases or decreases.
Which one works best? For Tjaden Lepp, most are useful and she is leery of leaning too heavily on any one indicator.
For Drozd, it’s the slow stochastic. After 25 years of watching charts, that’s what he finds most reliable. But he doesn’t recommend amateurs jump on that measure and expect it to work magically for them.
“There is no exact science about charting and technical analysis,” Drozd said.
“There is a lot of experience and interpretation that goes behind the recommendations that any analyst puts forward based on any of these signals.”
The RSI is popular with novices because it’s easy to understand. It’s one line on a chart that moves up and down on a one to 100 scale.
When the line drops below 30, most analysts considered that market to be in oversold territory and prices are baout to fall. When over 70, it’s overbought and prices could rise.
And often that becomes the case.
But Drozd said overbought or oversold conditions can last for weeks or months, and acting prematurely on a technical signal can cause hardship. Overbought markets may simply be a bull market in full rampage and not something to avoid.
“It’s not as simple as just using the RSI,” he said. “I wish it was.”
Drozd, who relies almost exclusively on technical indicators for his price and marketing suggestions, has developed his expertise to the point where he feels comfortable making bold recommendations, such as his pre-seeding call for possibly $7 wheat in 2007-08, based only on technical indicators.
Tjaden Lepp uses these indicators on a much shorter time scale, similar to most other analysts.
She spends most of her time analyzing what a farmer needs to sell, when and for how much to cover costs and earn a profit. After organizing a marketing plan that generally meets the real world cash requirements of a commercial farm, she turns to various forms of fundamental and technical analysis to pick nearby price points.
“We’re a lot more planning focused,” she said.
“The plan comes first, then the technical analysis follows it to make sure it gets done.”
If a certain amount of oats needs to be sold in a three month period, she brings out the technical tools to identify when prices should peak.
Most farmers don’t know enough about technical analysis to employ these indicators as successfully as professionals.
But beginning to watch them makes sense for those hoping to develop market timing skills.
After all, wouldn’t it be nice to be able to skip another Black Tuesday?
