The commodity market is incredibly broad and covers a wide range of fields. This could be agriculture, energy and minerals. To accurately keep track of all the activity, traders need to use many different perspectives on the possible value of a commodity. These perspectives can open up different avenues of opportunity, or strategies, depending on how they use them. This is why traders employ several different strategies when it comes to trading in commodities. The same strategy will not always work in every context, and every trader excels in their own particular method. In this article, we plan to introduce you to the most common strategies you have available to you. We will discuss the mechanisms of how they work and when to use them.
Types of Commodity Trading Analysis
Before we start, we should mention that there are two ways to analyse the value of a commodity. These are technical and fundamental analysis. We want to leave time for discussing strategies so we will talk in broad strokes. Technical analysis involves the following charts and using present and past trends to predict the future. It requires analytical skill and attention to detail and is more fast-paced. Fundamental analysis involves taking a look at the news and trading tips that could inform you of the direction of price movements. This type of strategy is much broader, and traders use it more for the long term. Traders use one or both of these strategies to different degrees.
Types of Technical Commodity Trading Strategies
Range trading strategy
This strategy involves determining which areas are over and undervalued. If a trader determines that a commodity is overvalued, they will, of course, sell that commodity. If they believe the commodity is undervalued, they will sell their share. The trader will then buy or sell the commodity when it has reached the opposite limit. These limits are the support and the resistance, the lower and upper limits, respectively. This is a short-term strategy used in volatile markets or volatile circumstances at the very least. Traders using this strategy will have to keep a close eye on the minute-to-minute developments in a market.
Therefore technical analysis comes highly recommended for this type of strategy. A good trader will, of course, be able to make a quick decision and realise if a commodity is over or undervalued before anyone else. After all, they will have to trade their commodity with somebody (if they have not used a contract, that is). Once the transaction has been made, a trader would usually expect the price to reverse to the mean (return to average), so they have to act fast.
The charts can inform a trader on much more than the current and previous value of a commodity. This could be the rate of a price change, the momentum, the relative strength index, and many others. These can further inform traders on how to act.
This strategy involves identifying new patterns to take advantage of. This may include looking for new up-and-comers, or deciding which commodities will under-perform. This is more of a long-term strategy and involves looking at the past behaviour of a commodity over a long period of time. If a commodity has a history of slowly increasing its highest value (or lowest value), it can be safe to say that it will reach a new record. Traders mainly inform themselves of this information by studying the charts, or in other words undertaking technical analysis. However, keeping an eye on the more fundamental aspects can give traders the extra evidence they need to make them secure in their decision. Generally, once this previously set price limit is broken, the previous resistance becomes the support for that commodity.
Fundamentally, this is the same strategy of buying high and selling low, but it tries to look at the broader picture of a commodity’s history. Because this requires looking at the history of a commodity over a long time, it is best not to use this strategy in highly volatile markets.
When keeping track of how a particular commodity is likely to do with fundamental analysis, there are several areas to look into. These can range from information that is easily digestible (world events, new policies), to serious number crunching. Therefore technical skill is still a necessity.
You will have to keep track of when a popular commodity tends to be popular, and how the supply is affected. We will use agricultural products as an example. Crop seasons can obviously have a huge impact on the availability of that commodity. For many agricultural products, summer is the best time to invest. However, to add to this theme you would have to keep track of local variables. In this case that would be the local climate. The Southern and Northern hemispheres have different climates at different times of the year. Although, areas around the equator enjoy roughly the same climate year-round. You will then also have to keep track of any events that could affect the local climate, whether there is a drought for example. Political events are also of the utmost importance. If a war, trade embargo, or numerous other events take place, you should pay attention.
The numerative aspects are also of utmost importance. Traders can keep an eye on the balance sheet, cash flow statement, and earnings report of a company. From this, you can derive further useful information not immediately present. For example, you can derive indicators like the earnings per share, price to earnings ratio, and many others. This can help a trader decide if the company is worth sticking with, or will incur losses in the future.
While this is all quite useful information it will likely not be of great use on its own. After all, everyone is looking at the exact same information you are, so unless you are incredibly swift you will have to find other methods. Thankfully, you can keep ahead of the curb by keeping your ears open for pre-announcement news. A company can inform investors on whether it believes targets will be met before publishing official data. This is the opportunity for a trader to decide and act before time runs out.
Strategies using this method involves buying a stock and holding it until the opportune time arises for the stock to be sold.
It is a strategy more commonly associated with long-term, methodical decisions. Although, a trader can use this strategy for short term gain. If you keep a close eye on what noted traders may say, they could give you a clue on sudden downturns or upturns. This can come from information not available to the average trader. It is overall a type of strategy that is far more speculative but can be more rewarding if it is stuck to.
So, there you have it. You can focus on fast-paced trading using the patterns of the past and the present. Or, you can focus on taking it slow and steady, gathering all the necessary information and trading when the time is ripe.