Agriculture Archives - Commodity Price Risk

Three Indicators to Start You Down the Technical Analysis Path – Part One

April 16, 2019

Likely, you have already heard about technical analysis. If you haven’t started using it yet, it could be because you are asking yourself, “How does it work in practice, and can I rely on it as a practical tool?” People ask me this all the time.

Starting to use technical analysis in your risk management programs may seem daunting, but the reality is that so many market participants use some of the core indicators in technical analysis today that studying them can help you understand the mood of the market. If you know which technical tools and indicators others are using to guide their decisions, it gives you a window into their thinking, like a chess match where you know the strategies your opponent regularly employs.

The first thing people should understand about technical analysis is that it doesn’t rely on one magical indicator. Looking at several indicators together can give you a more three-dimensional view of market sentiment. Doing so helps prevent blind spots or biases.

Looking briefly at a few indicators can help us grasp how they build a richer view of the market.

Three basic types of technical tools and indicators

1. Candlesticks

Among the oldest and most widely used technical tools, candlesticks first emerged in the rice market of Japan at some point in the last 200 years. They capture the open, close, high and low prices for a given period of time, as well as the overall intensity and direction of trading.

Closely analyzing candlesticks can help identify important price levels of support and resistance in the market. These levels reveal where many participants have set automated orders, and they essentially constitute the fair price of the moment. This gives you crucial information about what others are doing, thinking or perceiving, and which direction prices may go when they finally break through that level of support or resistance. It can help you cut through the noise of daily volatility.

Movements on candlestick charts can reveal key pricing levels like this one for soybean meal in 2017.

2. Moving averages

A weighted look at what prices have been doing during various intervals of the recent past can also give a good glimpse into market sentiment. The most basic form of this type of analysis is looking at simple moving averages compared to a price chart – 50- and 200-day moving averages are common intervals. When the market price crosses the 50-day moving average, this is a strong sign that a bullish or bearish trend is emerging.

Simple moving averages can confirm a new trend. For example, the 50-day average crosses the 200-day average right before a longer period of lower prices.

Exponential moving averages can be even more precise indicators. When comparing the exponential moving average of intervals such as nine, 12 and 26 days, you can see how directional momentum is building, because the more recent days are weighted more heavily. These averages can be compared in different ways using oscillator tools.

3. Fibonacci retracements

This indicator is shrouded in a bit of mystique. Fibonacci retracements are based on the golden ratio and the sequence of numbers studied by an Italian mathematician of the same name from the 13^th century. Fibonacci sequences are found everywhere in nature, and at some point, traders noticed that price movements and ensuing retracements can correlate to them as well.

Large price movements and the corresponding retracements toward previous levels frequently can correlate to percentages identified by Fibonacci sequences.

With so many participants watching Fibonacci sequences, the question becomes whether this type of pattern is some secret tendency of the market, or whether prices follow these ratios because everyone expects them to, making them a self-fulfilling prophecy. Regardless of which is true, the result is that they can often identify strong levels of near-term support and resistance in the market.

This article is the first in a series of two that can help you understand how technical analysis can help you decipher the sentiment of the market. Read Part Two to learn more about how these three indicators work together and how you can use them to provide you with more information that can help your business.

Three Indicators to Start You Down the Technical Analysis Path – Part Two

April 16, 2019

By Philip Archer

We started the conversation about the three indicators you can use to start you down the technical analysis path in Three Indicators to Start You Down the Technical Analysis Path- Part One. If you haven’t read it, I recommend starting there. The following information builds on that article by tying it all together.

Here’s a quick reminder of the three basic types of technical tools and indicators:

Candlesticks capture the open, close, high and low prices for a given period of time, as well as the overall intensity and direction of trading.
Moving averages provide a weighted look at what prices have been doing during various intervals of the recent past and can also give a good glimpse into market sentiment.
Fibonacci retracements are based on the golden ratio and the sequence of numbers studied by Fibonacci. These sequences are found everywhere in nature, and at some point, traders noticed that price movements and ensuing retracements can correlate to them as well.

How the indicators work together

The following series of charts layers the technical analysis indicators together to give a more complete picture.

Source: Reuters

Setting up your graph with a candlestick pattern will help you identify trading patterns. Before adding more technical tools, take a second to identify obvious trends.

Source: Reuters

This chart shows short-term trends up and short-term trends down, but by drawing support and resistance lines, you can identify a long-term range pattern.

Souce: Reuters

Simple moving averages of 50, 100 and 200 days remove the noise from strong market moves and allow you to identify levels where the market has traded the most for a specific period.

Source: Reuters

A Fibonacci retracement will confirm the technical levels identified by other technical tools and will give us additional support and resistance levels that other market participants are using as well.

How did we do?

The main goal of a technical analysis is to complement your market analysis based on fundamental factors. In this historical case:

We were able to identify strong support levels defined by lower and higher market prices during a specific period, and we marked them with red lines.
These technical levels were confirmed by the Fibonacci retracement that tell us market prices tend to move up or down in a numerical relation.
Additionally, the 50-, 100- and 200-day moving averages have given us levels that represent a compromise between buyers and sellers, meaning that on average, these are the levels where buyers and sellers have come to an agreement the most.

This technical and statistical information will add value to your market analysis and will be most important when fundamental factors are affecting market prices but their full impact is yet to be confirmed.

One common example of this is when there is damage to a crop that will affect its supply and make its price move. Until there is a clear understanding of the damage and its impact, the market will trade within technical levels because that is the information readily available. As more fundamental information arrives, the market price will adjust accordingly and may still follow some of those support and resistance levels set in your original technical analysis.

Take the leap

Technical analysis can provide a powerful context to price movements and help you decipher the sentiment of the market, and the three described above are just the beginning.

Technical analysis should be paired with caution, of course. Its conclusions may differ from the conclusions reached purely from the fundamentals. It presupposes that market prices have already absorbed all the fundamental information and biases that are available. Finally, it assumes some basic philosophies such as that history repeats itself, that the market moves in trends and that the market is essentially irrational.

Keeping these caveats in mind, there is real value in using technical analysis. In particular, it provides a rich view of what other market participants are likely thinking. In fact, because so many participants use its principles, this may be its most powerful aspect – simply understanding what many other people are likely to assume about the market’s trends. Without this information, you may have blinders on as you make your own decisions about how prices will move in the near future.

For this reason, if you have been hesitant to start using technical analysis, you may be at a disadvantage. It could be time to let go of your reluctance and take the leap.

How to Read the Market’s Irrationality

March 14, 2019

By Bernard Perin

For decades, analysts and economists held a fundamental belief that the individual player in the marketplace was a “rational economic man” who acted in his or her own best interest and made dispassionate choices based on all available data.

The reality that most experts have come to accept today is that this simply is not the case. The supposedly rational individuals operating in markets actually are often quite irrational or driven only partly by rationality.

Irrational behaviors from individuals added together create market trends, sometimes overshadowing the fundamentals. Prices can become self-fulfilling realities, as populations act around those perceived trends and only serve to reinforce them. In recent years, new networks of information have evolved to understand these forces. Today, charts provided through tools from Bloomberg, Reuters and others have become reliable ways to digest all of this information, both rational and irrational.

This market evolution has played out in different ways in agricultural commodities over the past couple of decades. An increased number of investors – many not tied to the physical supply chains of the commodities themselves – have created higher liquidity. Yet, they also have made the markets for those commodities more vulnerable to collective emotion. Today, with higher correlations across sectors like food and fuel, funds using non-fundamentals to trade larger volumes, and geopolitical headlines that create widespread apprehension of major moves, they have only gotten more turbulent. If you are not careful, this irrationality can leave you paralyzed and inefficient.

In the midst of this uncertainty, technical analysis has emerged as a way to examine the overall shape and sentiment of the market. Technical analysis can help you circumvent your own irrationality – that part of each of our brains that is highly averse to loss and seeks out patterns for guidance that may ultimately be misleading.

Technical analysis cannot predict the future. Despite what we may wish, it is not a crystal ball. However, it can be a sextant, guiding you toward the right strategies and products to meet your own goals in a market environment defined by both rational and irrational forces. It takes past analyses into account and uses them to understand what is happening today, as well as different scenarios that could unfold.

The fundamentals of technical analysis

At its most basic, technical analysis assumes that prices reflect all known information about the market: both facts and emotions. The emotion – individuals’ fear, greed, panic and overenthusiasm totaled up in the form of group behaviors – can dramatically affect prices.

When trying to break apart this collective irrationality, there are three central components to examine.

The first component is the set of trends in a market that illustrates patterns operating at a point in time. This is the way individuals and groups look at what is happening now and make decisions about the degree to which it will continue to happen.

These assumptions are the consequence of heuristics such as simplification, filtering, framing, magnification and others. They are attempts by our brains to cope with the noise, and many of them are particularly prone to recency bias. Yet they also are often self-reinforcing when enough people hold them, as belief becomes truth in the market.

The second component is the market psychology that arises in the face of these trends. Our psychological constitution leaves us much more averse to losses than attracted to gains. Avoidance of regret is a primary human motive. Often, fear of making the wrong choice can lead to paralysis, when action would be the best course. The field of behavioral finance pays particular attention to the unexpected, illogical or irrational decisions we make when faced with this fear.

Third is the market’s strength. Here is where technical analysis seeks to decipher the market’s forces through indicators such as Ichimoku clouds and many others. Their purpose is to tell us how the market is reacting. They can have a strong descriptive and predictive potential by explaining not only how the market is moving, but what limits it might move within during the near term.

The value of a clearer head

The process of technical analysis is one of constant validation or invalidation, reassessment, and new assumptions. By measuring how fundamentals are being interpreted in the market and also how price is reinforcing itself through trends – the emotions and behaviors they are generating – you can manage the emotion of your own pricing decisions. It provides a different perspective and a complementary set of tools to traditional fundamental analysis. This is what we share with clients.

There is an apocryphal saying attributed to a few different economists: “Markets can stay irrational longer than you can stay solvent.”

The collective emotion in today’s commodities markets combined with your own individual emotion can throw your risk management strategy off track. The result can be that sinking feeling when you realize you made a trade that is not going to work out in your favor.

Consider using technical analysis to help lower the chances of having that feeling in the future.

*Chart source: Bloomberg Terminal by Bloomberg

Dairy Revenue Protection Insurance: A New Tool for the Dairy Producer

January 31, 2019

By Cargill Risk Management

Last fall, the U.S. Department of Agriculture’s Risk Management Agency announced a new insurance plan for dairy producers. The new “Dairy Revenue Protection,” program provides insurance on a quarterly basis for the difference between the final revenue guarantee and actual milk revenue if prices fall.

The plan is flexible, providing two pricing options: class price and component price. Additionally, producers can lock in coverage for 70 to 95 percent of revenue, in increments of 5 percent.

The program is seen as an expansion of the Federal Crop Insurance Act that was set up years ago. And, like that program, this one is subsidized by the government and based on the futures prices, in this case using CME class 3 and class 4 milk futures. Unlike previous programs, however, this one focuses on revenue insurance rather than income minus feed costs. The subsidy currently amounts to 44 to 59 percent of the premium cost of the insurance.

The big question: Will dairy producers take advantage of this new program? Although the answer may seem to be a resounding yes, ultimately there are other considerations that producers should consider. Even if the new program is utilized, producers should consider ways to enhance their revenue through complementary price risk management strategies.

Price Risk Management Tools for the Dairy Producer

In a comprehensive risk management approach, Dairy Revenue Protection should be just one tool in a producer’s toolbox. Ideally, they should also be using other risk management tools such as exchange traded futures, options, over-the-counter (OTC) products, and potential cash market tools between buyer and seller. All of these can help to create a diversified approach to hedging and provide flexibility depending on changes in market price and volatility.

As dairy producers plan for 2019, it is likely many are still determining how the Dairy Revenue Protection offering will fit into their business. Initially, there may be slow adoption as a result. The government shutdown is sure to exacerbate this as well. However, adoption could ramp up quickly, depending on how the market evolves, particularly if futures prices continue to rally.

As these aspects of the market sort themselves out, it’s important to remember that Dairy Revenue Protection – no matter how useful it may be – is just one option among many available to producers. A comprehensive risk management strategy can help alleviate some of the difficulties of a downturn in the market like the one producers have been experiencing in the U.S. dairy sector.