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Price Trend Analysis

How to determine price range and direction

One of the key issues in marketing, of course, is deciding whether you think prices and basis are headed up or down. Farmers and marketing advisers alike often say their goal is to sell in the upper one half or one third of the price range and avoid sales in the bottom one third of the price range. The question, of course, is how does one know the price range? Likewise, a farmer's choice of marketing strategy differs when the market is headed higher than when it is falling. How does one know the trend?

Perhaps the simplest way to deal with market risk is to assign sales to one or more automated contracts offered by grain buyers. These include seasonal average contracts and some based on advice of marketing professionals. There generally is a 1¢ to 3¢/bu. charge for these contracts. The advantage is you don't need a brokerage account and, in most cases, you don't need to make margin calls on futures positions. Some elevators require delivery at their facility; others offer these contracts as part of a marketing service with no delivery requirement. Most limit the amount of production you are permitted to sign up in these contracts to 50% or less, however, so you are still left with decisions on the remainder of your crops.

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Another way to deal with the issue of outlook is to rely on a market adviser. Better yet, divide your crop among several, since history has proven that no one adviser clearly stands out as superior to the others ( For a study of advisers' results, see: www.farmdoc.uiuc.edu/agmas ). Most producers we know prefer to use their own analysis and judgment.

One of the more successful approaches when developing an idea of price direction is the blending of fundamental information with the use of a specific technical indicator.  Ultimately, fundamentals will determine price, but two flies are always in the ointment:  (1) Fundamentals are an ever-changing target because weather is always such a big variable with supply, and (2) demand is a changing component because of many factors, including price fluctuations (that is, high prices reduce demand and low prices increase demand), transportation costs, and politics, to name a few.

FUNDAMENTALS

USDA and advisory services develop expected futures trading ranges based on current knowledge of supply and demand and how prices have reacted to similar fundamentals in the past. The following diagram illustrates the price range expectations of Informa Economics, Memphis, in the fall of 2005. These expectations may change monthly, on USDA reports, or even daily as news events occur.

Such price ranges can be used both to assess whether the current price is a good one compared with expectations and to choose a tool based on the expected price direction.

In this example, futures prices in January 2006 were expected to be in a trading range of $5.25-$5.75, as marked by the two dark lines. The price shown for January soybeans (small square) was $5.70, which was on the high side of their expected trading range. If you look out to August of 2006, Informa's price targets were even lower.

TECHNICALS :

Technical indicators can provide a snapshot of the market and signal that prices are about to reverse direction. They cannot tell us how long a direction will last.

A few popular and easily used indicators follow:

I. Moving Average

Moving Average is generally used to identify or confirm a trend, and works best in trending markets. It will not signal you that a trend change is imminent, but it will help you determine whether an existing trend is still in motion and confirm when a trend reversal has taken place.

A simple moving average usually uses the closing price. It can be any number of days. For example: a 5-day simple moving average is calculated by adding the closing prices for the last 5 days and dividing the total by 5 (2.30 + 2.32 + 2.28 + 2.33 + 2. 36 = 11.59 ÷ 5 = 2.318). Each day, you would drop the first day in the series and add the current day. Connecting the dots forms a smooth line that reveals whether a trend exists.

II. Moving Average Convergence Divergence (MACD)

The MACD, developed by Gerald Appel, is both a trend follower and an oscillator. It is the difference between a fast Exponential Moving Average (EMA)—often a 12-period average--and a slow (perhaps 26-period) EMA. The CD in MACD stands for Convergence Divergence, indicating that the fast EMA is continually converging towards or diverging away from the slow EMA.

An oscillator is the simple difference between two moving averages. Some studies plot the difference between two moving averages and those values oscillate around a zero line. You sell when the oscillator crosses the zero line from above to below and buy when the oscillator crosses from below to above. Some traders like to buy the valleys and sell the peaks of an oscillator.

A third Exponential Moving Average of the MACD ( trigger, or the signal line) is then plotted on top of the MACD.

When the MACD crosses above the signal line, an uptrend may be starting, suggesting a buy. Equally, the MACD crossing below the signal line may indicate a downtrend and a sell signal. The crossover signals are more reliable when applied to weekly charts, although this study may be applied to daily charts for short-term trading.


Courtesy of Strategic Marketing Services

III. Bollinger Bands

Bollinger Bands consist of a moving average's standard deviations charted as one line above and one line below the moving average. The line above is two standard deviations added to the moving average. The line below is two standard deviations subtracted from the moving average.

John Bollinger, the creator of this study, states that periods of fewer than 10 days do not seem to work well, and the optimal period is 20 or 21 days.

Traders generally use Bollinger Bands to determine overbought and oversold zones, to confirm divergences between prices and studies, and to project price targets. The wider the bands, the greater the volatility. The narrower the bands, the less the volatility.

IV. Stochastic

The Stochastic Study, developed by George Lane, is an oscillator that compares the difference between the closing price and the period low, relative to the trading range over an observation time period. The basic premise is that during periods of price decreases, daily closes tend to accumulate near the lows of the day and vice versa. The Stochastic is an oscillator designed to indicate oversold and overbought market conditions.

The stochastic (a mathematical calculation) is composed of two lines, known as the %K line (the number of periods such as days, weeks or months on the chart) and the %D line (the number of periods used in the moving average calculation). These oscillate between 0% and 100%. The %K line is calculated from the difference between today's closing price and the period low, divided by the difference between the period high (highest high) and the period low (lowest low). The %D line represents a simple moving average of the %K line, and thus reacts less sensitively than the %K line.

 


Courtesy of Strategic Marketing Services

V. Bullish Consensus, Sentiment or Contrarian Opinion

During major bull markets, the psychology of investors moves from pessimism and fear to hope, overconfidence, and greed. For the majority, the feeling of confidence is built up over a period of rising prices, so that optimism reaches its peak around the same point that the market is also reaching its high. Conversely, the majority is most pessimistic at market bottoms, at precisely the point when buying should be taking place.

The better-informed market participants act in a contrary manner to the majority by selling at market tops and buying at market bottoms. It has been said that trader sentiment determines the course of the markets. If enough traders are bullish, even for the wrong reasons, then prices will rise. You don't need to know why those traders are bullish, only that they are willing to buy and drive prices higher. That's where the Bullish Consensus comes in. It measures the futures market sentiment each day by following the trading recommendations of leading Commodity Trading Advisors. The Bullish Consensus can allow you to trade with the trend each day until a Contrary Opinion situation develops.

This poll of leading analysts and advisers has been going on since 1964. Over a period of years, it has been possible to identify levels for various markets that indicate when a market has moved to an extreme, historically associated with a major turning point. For example, perhaps when Bullish Consensus is below 16% (very oversold), it is time to buy, and when it is over 60% (quite bullish), it is time to sell. See www.sentimentrader.com/subscriber/surveys_marketvane_description.htm or www.consensus-inc.com.

VI. Large Spec Position Tracking

It is important to notice the aggregate position of the large speculators because it can show a possible swing in the market's direction. Using November soybeans as an example, the large specs biggest net long position occurred on August 2nd, with more than 46,000 contracts. At that time, November beans were trading at 7.04 ½. The large specs slowly unwound their large net long position into a closer to neutral position (estimated net long 7,100 contracts as of Monday 9/26).

As you can see from the chart below, the contract traded steadily lower after specs began selling. The large specs sold out of their long positions, thus providing a stimulus for the market to move lower. When the large spec begins to build a sizable long or short position, these price swings are likely to take place (the question is when). The table details the estimated large spec positions for the same time period. To get daily updates of large spec positions, visit http://www.agresource.com/FundActivity.asp

Lastly: Do your homework everyday

Every day is a new day requiring one to review, review, and further review your marketing plan. Look for changes in fundamental and/or technical analysis and commit to act on those changes when they occur. Managing price risks requires an ability to define price trends and the confidence to initiate strategies to capture profitable pricing opportunities.

 

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