The other day I heard a Wall Street technical analyst describing how he pegs a significant market turn. He said he uses a combination of the MACD (Moving Average Convergence Divergence), a notable non-confirmation from an index other than the one he’s playing, and two other factors whose nature I now forget. That’s a serious way to do technical analysis and common among professionals.
But it’s beyond most folks’ abilities. I’ve studied technical analysis and managed to get honours in the Canadian Securities Institute’s tech analysis course, and I wouldn’t feel too confident employing a complex combination like that to move real money (or thousands of tonnes of crop) around. So can average Joes like me and most of you out there use technical analysis when we’re deciding how to lock-in prices in the market?
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I think the answer is yes – but very carefully. There are a few basic measures of market direction that can be used simply to give a pretty good sense of the strength of a movement. Analyst Larry Weber of Saskatoon gave a helpful explanation of one of these measures during presentations he gave at Crop Production Days in Saskatoon last week and at Manitoba Ag Days in Brandon this week. He showed how the Relative Strength Index can be used to tell whether a market, such as canola futures, is in a generally oversold or overbought condition. My markets editor, D’arce McMillan, wrote his column about Larry’s presentation for the issue of The Western Producer that comes out today, so I won’t go too deeply into what Larry said. But his general message was that the RSI has a fairly good record of highlighting buying and selling opportunities in the canola market. When it’s pushed above 70 (on a one to 100 scale) it generally has accurately marked a nearby top, and when it’s fallen below 30 the short-term low is close. Larry cautioned growers to not base everything on gauges like the RSI, but to see it as a helpful addition to other tools. That sounds sensible to me.
I’m a fan of the RSI. I’ve watched it over the years with various stocks and commodities, and in a longer-term trending market it often signals important turns. But it can be maddening if you rely on it too much. And it can completely miss major turns that aren’t just deviations from long term trends, and it can send false signals. Check out this chart of corn prices:
(The price is the top chart. The RSI is the bottom chart.) The RSI did signal the end to a rise into late October, but if you’d gone short corn after the first of these peaks above 70 you wouldn’t have subsequently have gotten an opportunity to buy back in at a much lower level. The market went sideways for a couple of months instead of reversing. Then later when the corn market crashed, after the USDA reports last week, you would have been mightily annoyed if you’d been relying solely on the RSI to send you a sell signal. It was floating around 60, which is on the high end for overboughtness, but not near enough to the 70 trigger. So you would have been hanging on in a long position and wouldn’t have had time, after a major slump like started last Tuesday, to get out without losses. (Note that right now it’s signaling oversoldness.)
Here’s another situation that would cause you problems if you relied solely on the RSI:
This weekly corn chart with the RSI beneath shows that the RSI would indeed have signaled an upcoming turn in the corn market in mid-2008. But if you pulled the sell trigger once it hit 70 you would have cashed out at around $4.75 per bushel, not at the $7.00-plus levels it soon got to. (Daily charts would show slightly different RSI readings.) That’s a lot of money left on the table. And it was below 70 at the ultimate peak, on the weekly chart at least. So if you hadn’t sold at by that point, you would have kept hanging on. And while the RSI did tickle 30 at the 2008-09 market low, it didn’t move clearly beneath it. You might not have felt it was a clear enough signal to move on. And you might have used it to buy-in too early, because the first 30 readings occurred a significant time before the real bottom.
So here are cases of where the RSI didn’t fire off its sell signal before a major downside reversal, where it started signaling prematurely, and where it didn’t send a definite signal at a turn. That isn’t a problem for the RSI, because practitioners will point out that it merely highlights possible situations of overboughtness and oversoldness, but it is a problem for anyone who employs it too simplistically. All tools have their place. They can be generally reliable. But they’re mechanical, and their parts break when the wrong sort of stress is placed on them.
Technical analysis is always more of an art than a science, so while various gauges can be useful, in the end you’ve got to chuck them into the hopper with all your other marketing info and go with your gut.
