Updated on July 23, 2024
Investors are increasingly interested in ways to hedge their portfolios from the oncoming inflation and might find information about commodity trading strategies relevant. This article sheds light on strategies you could use to successfully buy and trade commodities in 2023.
Commodities refer to raw materials used in the production of goods. They are typically subdivided into hard commodities mined from the earth, such as gold, oil, silver, and platinum, and soft commodities, which are merely cultivated, such as corn, wheat, coffee, and others.
Commodity investment offers a range of benefits to investors, including hedging against inflation, diversification of risk, and the potential to attract risk-adjusted returns. However, for newbie investors, venturing into the world of commodity investing can seem intimidating. This article breaks down a few winning strategies you can use while trading commodities.
General Rules of Thumb
Before we explore specific strategies used by commodity investors to win in the marketplace, here’s an outline of general rules of thumb to remember as you execute your trade strategies.
Follow Trends
A simple strategy employed by novice and experienced traders is spotting trends early. In many instances, following trends makes more sense when faced with market anomalies. Traders more aptly put it when they say, ‘the trend is your friend,’ an expression that encapsulates how trusted this strategy is by those who’ve been trading for a long time.
In the presence of contradictory information, following strong trends might be your best bet to emerge with positive results. Therefore, supposing the market is moving up on the back of a strong trend, you might be better off ignoring other trading strategies and simply using the trend as your north campus. This obviously doesn’t mean that all your trades will be winners, but it is a soft guarantee that your general trading approach will fall right into place.
Buy the dip
This is an investment strategy that means the act of purchasing more assets even as the price continues to fall or even once it settles. Seasoned investors recommend this move when faced with a stagnant or bull market in which the trend is rising or sideways.
This strategy has proven effective for many investors by following historical data, analyzing charts, analyzing short-term and long-term average movements, and laddering buys. After buying a dip, the investor can choose whether to sell for a quick profit or hold and build a long-term position. They might also opt to use it to get incremental gains. All in all, the strategy advocates for purchases at lower prices, not high.
Although buying the dip is a solid strategy, caution must be exercised as it can be challenging to know just how low the prices will go before rebounding the next day or even hour. Another way to potentially enter the market is to buy when the price of the asset rates lower in comparison to its average historical projection.
A good charting tool to monitor the moving average would help determine the best points to enter and exit the market.
Use charts
Learning to read charts might seem daunting to some investors, but there is no way around this strategy. In order to truly succeed at commodity trading, you need to know how to read and analyse charts. With the help of charts, you can predict an asset’s future direction, find essential patterns, and understand the market better. This is an integral part of technical analysis that will prove immensely beneficial once you get accustomed to the practice.
The most basic form of technical analysis involves looking for support and resistance levels that markets have previously failed to overcome. Technical analysis is also instrumental in recognising trends. Another relatively simple way of utilising charts is to analyse moving averages, for example, the average price over 15 days. The reasoning behind this is that this gives you a clearer idea of what the price is doing over the long term.
Developing a trading strategy: Technical Indicators
The strategies highlighted in this article are based on technical analysis, meaning you will need a good understanding before applying them. In addition, you will need a good charting tool to take full advantage of these strategies.
1. The Moving Averages Strategy
This gives you an idea of the market’s direction and is very useful for identifying trends. At its most basic level, moving averages can be utilised to calculate the price of a commodity at a specific time. A trend is a good entry signal. However, a disadvantage of moving averages is that they typically lag the market. This strategy should be used for shorter periods, such as 5 or 6-day moving averages, to reflect the current price direction.
Moving averages are usually used as a trend line, which mimics and adjusts to price changes. The following signals can be got from the moving averages strategy;
- Closing price moves above the moving average = buy signal.
- Closing price dips below the moving average = sell signal.
2. The Crossover of Moving Averages Strategy
This is another strategy you can utilise to spot a trend. This strategy comprises two moving averages; a fast-moving average (e.g., 10 bars) and a slow-moving average (e.g., 15 bars). Typically, the slow-moving average uses more days than the fast one.
Many investors prefer a crossover because it eliminates considerations driven by emotion. Moving average crossovers can assist traders highlight potential areas of resistance or support. In all cases, they are based on historical data and basically indicate the average price over a certain period of time. The standard type of crossover is where the price of an asset moves from one side of a moving average and closes on the other.
Investors use price crossovers to track changes in momentum and can thus be used as a simple entry strategy. The crossover of the moving averages strategy gives you the following signals;
- If the fast-moving average crosses the slow moving average from below = buy signal
- If the fast-moving average crosses the slow moving average from above = sell signal
3. The Turtle Trading Strategy
Richard Dennis and William Eckhardt were the creators of the turtle trading strategy, which basically consists of buying during a breakout and then quickly selling once the price drops. This is one of the more popular strategies used by traders. The basic premise of this strategy is that it is used to evaluate the high and low over the past 20 days. According to this strategy, ‘trend is your friend,’ and therefore, you should purchase futures breaking out higher than trading ranges and sell when the opposite happens. This strategy gives an investor the following signals;
- When the current prices move higher than the high of the previous 20 bars = buy signal.
- When the current prices move lower than the low of the previous 20 bars = sell signal.
4. The Moving Average Convergence Divergence Strategy (MACD)
The MACD strategy is also very useful in identifying trends. This indicator takes advantage of the relationship between two moving averages of prices. In most cases, traders use the difference between a 26-bar exponential moving average and a 12-bar. The difference is then plotted on a chart and shifts above and below zero. A 9-bar exponential moving average of the MACD, referred to as the “signal line,” is then plotted on top of the MACD, functioning as an indicator for buy and sell signals.
Although the strategy can be used in numerous ways, investors commonly use the signal line for entry signals, as shown below;
- If the signal line crosses the MACD from below = buy signal.
- If the signal line crosses the MACD from above = sell signal.
5. The Williams Percent Range Indicator Strategy
Larry Williams came up with this strategy, and it helps identify overbought and oversold positions in the market. It is commonly characterized as an “oscillator” because its values vary between 0 and “-100”.
The indicator chart typically has lines drawn as alert signals at both -20 and -80 values.
Values between -80 and -100 = strong oversold condition/ sell signal.
Values between -20 and 0 = strong overbought condition/ buy signal.
The Williams percentage range indicator strategy gives you these signals;
- If the indicator has a value over 80 = sell signal.
- If the indicator has a value below 20 = buy signal.
6. Relative Strength Index Strategy
This was created by Welles Wilder and is another overbought/ oversold signal. The goal of this strategy is to determine the comparative changes that occur between the higher and lower closing prices. Traders typically use this index to determine overbought/ oversold conditions, which in turn helps them determine the underlying asset’s entry and exit points.
The RSI is also an oscillator strategy with its line swinging between the values of 0-100. Additionally, 70 and 30 are significant values because above and below them are the overbought and oversold positions, respectively. This strategy gives you the following signals;
- If the RSI crosses the 70-line, overbought zone from above = sell signal.
- If the RSI crosses the 30-line, oversold zone from below = buy signal.
7. The Bollinger Bands and Channels Strategy
This strategy incorporates a moving average and two standard deviations; one above the moving average and one below. The important thing to remember about Bollinger Bands is that they consist of up to 95% of the closing prices. Using this strategy can help an investor fully understand several characteristics of an asset, e.g., the high or low of the day, whether the asset is trending, and it’s level of volatility or stability.
In some instances, when trading Bollinger Bands, one may notice the bands coiling really tight. This is an indication that the asset is trading in a narrow range. Indeed it is a trigger to look at for a price breakout or breakdown. This strategy gives you the following signals;
- If prices move above the upper Bollinger Band = sell signal.
- If prices move below the lower Bollinger Band = buy signal.
Summary
Commodity trading strategies offer investors a range of benefits, including hedging against inflation and the potential to attract risk-adjusted returns. To be successful in trading commodities, investors should follow general rules of thumb such as following trends, buying the dip, and using charts. Popular strategies employed by traders include the moving averages strategy, crossover of moving averages strategy, turtle trading strategy, MACD strategy, Williams percent range indicator strategy, relative strength index strategy, and Bollinger bands and channels strategy. Each of these strategies provides investors with buy and sell signals that enable them to enter and exit the market at the right time.
How can I use charts to analyze the market?
Charts are a key tool in helping investors analyse the market, as they allow investors to identify trends, spot potential areas of resistance or support, and calculate the average price over a certain period of time. By using charts and applying the strategies outlined in this article, investors can gain a better understanding of the market, enabling them to make more informed decisions in their trading.
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