The premise of commodity trading strategies.
If you recall our
previous article about the commodity markets, you may remember that all trading involves the use of futures and options. These derivative types are employed in an attempt to capitalize on the movement of prices. This makes sense when you consider that these derivatives are valued based on some underlying asset. Hence, we are trying to profit on the price fluctuations of various commodities.
The two main categories of commodity trading strategies.
Just like with stocks, commodity trading strategies can be used at both technical and fundamental levels. Recall that technical analysis deals with analyzing the historical pricing patterns of a particular asset. On the other hand, fundamental analysis deals with examining macroeconomic factors like supply and demand.
Technical trading strategies for commodities.
When it comes to technical trading strategies, there are two major strategies you can use in the commodity market. The two methods go by the names of range trading and breakouts. We will discuss each one in detail.
Range trading. This strategy entails buying at the low end of a range and selling at the high end – or at least attempting to. Here you will try to time when a particular commodity is either overbought or oversold. For the former situation, you will want to sell your commodity whereas in the latter you will want to buy more. Let’s explain why. When a commodity becomes overbought, it means that demand outweighs supply. In this case, the price will rise. However, when a commodity is oversold, supply outweighs demand. Accordingly, the price will drop. Here’s a word of caution before you dive in.
Breakout strategy. A second option when it comes to technical trading is the breakout strategy. This involves timing deals that occur outside of the range we relied on in the previous strategy. Here you will want to attempt to identify when the commodity will reach new highs or drop to new lows. The key is to identify strong trends among commodities and take advantage of them. However, this strategy becomes quite difficult to employ when a commodity struggles to display a strong trend.
Fundamental analysis for trading commodities.
As we briefly mentioned earlier, fundamental analysis deals with the examination of underlying macroeconomic factors. Here you are working to uncover various factors that will affect the supply or demand of a particular commodity. Based on your findings, you may think that a commodity’s price is likely to increase. Or, it could be the opposite and you think it will decrease. This analysis will help to form the basis of your trades going forward. Typically, fundamental strategies occur over a longer term than technical ones. This is based on the fact that you never know for sure how long it will take for your hunch to play out.
So which strategy is best?
No one single strategy is necessarily better than the others. Each one has its pros and cons, but it’s up to you to decide which one you are most comfortable employing. Take fundamental analysis for example. This approach can be very complex due to all of the factors that come into play. Generally, if you combine elements of both fundamental and technical analysis you can have the best of both worlds. Findings from each approach will help to inform your overall decision as each one reveals different insights. Again, it’s up to you to figure out what works best for your trading style.
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