fundamental and technical analysis of commodity

7/21/2019 Fundamental and Technical Analysis of Commodity

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Lecture 4Fundamental and Technical Analysis

Primary Texts

Edwards and Ma: Chapter 16

CME: Chapter 8

Web Resources

http://stoccharts!com/schoo"


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Volatile Futures Prices


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Trading Futures

Tradin# $utures as a specu"ator is no di$$erent $rom tradin# any

other commodity or asset! %uccess depends on the abi"ity to &ccurate"y predict $utures prices' and

E$$icient"y mana#e riss

Two techni(ues are common"y used to $orecast prices

)undamenta" &na"ysis Technica" &na"ysis

There are *arious strate#ies $or mana#in# the riss associated

with tradin#!


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Fundamental Analysis

)undamenta" ana"ysis sees to identi$y the $undamenta" economic

and po"itica" $actors that determine a commodity+s price!

,t is basica""y an ana"ysis o$ the -current and $uture. demand $orand supp"y o$ a commodity to determine i$ a price chan#e is imminent' and

in which direction and by how much prices are expected to chan#e!

This approach re(uires gatheringsubstantia" amounts o$ economic data and po"itica"

inte""i#ence' assessingthe expectations o$ maret participants' and analyzingthese in$ormation to predict $utures price mo*ement


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)undamenta" ana"ysis $ocuses on cause and e$$ect causes

externa" to the tradin# marets that are "ie"y to a$$ect prices in

the maret! These $actors may inc"ude the weather' current in*entory "e*e"s'

#o*ernment po"icies' economic indicators' trade ba"ances and e*en

how traders are "ie"y to react to certain e*ents!

)undamenta" ana"ysis maintains that marets may misprice a

commodity in the short run but that the 0correct0 price wi""

e*entua""y be reached! Pro$itscan be made by tradin# the

mispriced commodity and then waitin# $or the maret to

reco#nie its 0mistae0 and correct it!
http://en.wikipedia.org/wiki/Profit_(accounting)http://en.wikipedia.org/wiki/Profit_(accounting)


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Various Techniques of Fundamental Analysis

The 2emand3%upp"y )ramewor

Price E"asticity

The 4a"ance Tab"e

%tocs3to32isappearance Ratio

The Tabu"ar and 5raphic &pproach The Re#ression &na"ysis

Econometric Mode"s

%easona" Price ,ndex



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Market Demand Maret demand represents how much peop"e are wi""in# to

purchase at *arious prices! Thus' demand is a re"ationship between price and

(uantity demanded' with a"" other $actors remainin# constant!

Fundamental AnalysisThe Demand!"u##ly Frame$ork

The economics o$ consumer

beha*ior deri*es the "aw o$

demand

When price o$ a #ood #oes up'

peop"e buy "ess o$ that #ood

eads to downward s"opin#

demand cur*e


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%hanges in Market Demand Price chan#e does not "ead to chan#e in demand Chan#e in anythin# other than price "ead to demand chan#es 3

&ntire cur'e shifts ,ncome Price o$ re"ated #oods 3 "u(stitutesand %om#lements Consumer pre$erence or Taste

%a"es Tax Consumer Expectations about $uture prices' product

a*ai"abi"ity' and income

Rise in demand 7 the demand cur*e shi$ts to the ri#ht

)a"" in 2emand 7 the demand cur*e shi$ts to the "e$t!


The Demand!"u##ly Frame$ork


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Market "u##ly Maret supp"y represents how much producers are

wi""in# to se"" at *arious prices! Thus' supp"y is a re"ationship between

price and (uantity supp"ied' with a"" other $actors remainin# constant!

Fundamental AnalysisThe Demand!"u##ly Frame$ork

Theproducer theory deri*es the

"aw o$ supp"y

When price o$ a #ood #oes up'

(uantity supp"ied #oes up eads to an upward s"opin#

supp"y cur*e


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%hanges in Market "u##ly Price chan#e does not "ead to chan#e in supp"y Chan#e in anythin# other than price "ead to supp"y chan#es 3

&ntire cur'e shifts Production costs

,mpro*ement in production techno"o#y

Chan#e in the wa#e rate

Weather condition Excise Tax

Rise in %upp"y 7 the supp"y cur*e shi$ts to the ri#ht

)a"" in %upp"y 7 the supp"y cur*e shi$ts to the "e$t!




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Market &quili(rium &ctua"

price and uantity determined

by interactions between

demanders -consumers. andsupp"iers -se""ers.

&quili(rium Point The point

where the maret demand andsupp"y cur*es intersect

Price at which (uantity

demanded e(ua"s (uantity

supp"ied




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The &ffects of

"u##ly and

Demand "hifts


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&"thou#h price is determined by the intersection o$ the maretdemand and supp"y cur*es' typica""y demand is not readi"y(uanti$iab"e!

The on"y theoretica""y acceptab"e means o$ (uanti$yin# demand isto estimate demand cur*es throu#h a detai"ed ana"ysis o$ historica"consumption and price data! 2emand $unction $or corn:

With historica" data on QCorn'PCorn'PWheat' andI, one can estimate '' '

and .

%imi"ar"y the supp"y $unction can a"so be estimated usin#

historica" data!



IPPQ WheatCornCorn +++=


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The "aw o$ demand imp"ies that the demand cur*e is ne#ati*e"y

s"oped! 9owe*er' the s"ope may *ary!

%teep"y3s"oped demand cur*e 7 ,ne"astic demand

ar#e chan#e in price "eads to sma"" chan#e in (uantity

demanded

)"at demand cur*e 7 E"astic demand

%ma"" chan#e in price "eads to "ar#e chan#e in the (uantitydemanded

The e"asticity o$ demand is primari"y determined by two $actors &*ai"abi"ity o$ substitutes

Percenta#e o$ tota" income spent on the #ood




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The Price &lasticity of Demand

The price e"asticity o$ demand is a measure o$ the

responsi*eness o$ (uantity demanded to a price chan#e )$n Price &lasticity of Demand: The percenta#e chan#e in the

(uantity demanded re"ati*e to a percenta#e chan#e in its ownprice!

)or a smooth -di$$erentiab"e. demand cur*e' the price e"asticityo$ demand is #i*en by

D

D

D

DD

Q

P

P

Q

P

P

Q

QE

=

=

D

DD

Q

P

P

QE

=


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The Price &lasticity of Demand

E"asticity is a pure ratio independent o$ units!

%ince price and (uantity demanded #enera""y mo*e in

opposite direction' the si#n o$ the e"asticity coe$$icient is

#enera""y ne#ati*e!

,nterpretation: ,$ED 3 ;!


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Examp"e E"asticity o$ 2emand $or Cotton:Ed* + ,-./

Cotton disappeared in (uarter > o$ ;?1? 6!6@ bi""! bs

Cotton disappeared in (uarter @ o$ ;?1?

= chan#e in E(! uant! 2em! BQ/Q -

Ed -BQ/Q. /-BP/P.

+ ?!6


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Fundamental Analysis%ross Price &lasticity of Demand

The cross price e"asticity o$ demand is a measure o$ the

responsi*eness o$ (uantity demanded o$Xto a price chan#e o$ Y %ross Price &lasticity of Demand: The percenta#e chan#e in

the (uantity demanded o$Xre"ati*e to a percenta#e chan#e inthe price o$ Y!

)or a smooth -di$$erentiab"e. demand cur*e' the cross pricee"asticity o$ demand $orXis #i*en by

X

Y

Y

X

Y

Y

X

XDXY

Q

P

P

Q

P

P

Q

QE

=

=

X

Y

Y

XDXY

Q

P

P

QE

=


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Fundamental AnalysisThe Price &lasticity of "u##ly

The price e"asticity o$ supp"y is a measure o$ the responsi*eness

o$ (uantity supp"y to a price chan#e )$n Price &lasticity of "u##ly: The percenta#e chan#e in the

(uantity supp"ied re"ati*e to a percenta#e chan#e in its ownprice!

)or a smooth -di$$erentiab"e. demand cur*e' the price e"asticityo$ demand is #i*en by

S

S

S

SS

Q

P

P

Q

P

P

Q

QE

=

=

S

S

SQ

P

P

QE

=


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Forecasting Price =sing the

&quili(rium Dis#lacement Model

The concept o$ e"asticity is a"so use$u" $or $orecastin#

chan#es in prices and (uantities resu"tin# $rom supp"y and

demand cur*e shi$ts! %upp"y o$ por decreases due to a tou#her re#u"ation on manure

treatment and disposa"

2emand $or por increases due to an increase in the price o$ bee$

,$ we now the e"asticities o$ demand and supp"y' we canca"cu"ate the chan#es in price and (uantity demanded -or

supp"ied. by incorporatin# e"asticities into a mode" ca""ed an

equili(rium dis#lacement model!


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Demand &quation

Qd -price' income' tastes and pre$erences' expectations'

and prices o$ other #oods. 2emand chan#es -shi$ts. i$ any ri#ht hand side $actor other

than price o$ the commodity chan#es

"u##ly &quation

Qs -price' input prices' prices o$ other #oods'expectations' techno"o#ica" chan#e' number o$ producers.

%upp"y chan#es -shi$ts. i$ any ri#ht hand side $actor other

than price o$ the commodity chan#es


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&quili(rium Price and (uantity are determined by the

intersection o$ the demand and supp"y cur*es' where

Qd* Qs -i!e!' (uantity demanded (uantity supp"ied.

E(ui"ibrium chan#es -#ets disp"aced. i$ demand and/or

supp"y chan#es because o$ chan#es in any ri#ht hand side

demand and/or supp"y $actor other than the price o$ the

commodity!

%uppose that an increase in income shi$ts the demand cur*e

to the ri#ht' and an increase in the production cost shi$ts the

supp"y cur*e to the "e$t! &s a resu"t' new e(ui"ibrium price

wi"" be hi#her and e(ui"ibrium (uantity wi"" be "ower!



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We can $orma"ie this concept and write the demand e(uation as

%QdEd7-%P6 3Sd Where'Ed is the e"asticity o$ demand

Sdrepresents any exo#enous demand shi$t 7 the percenta#e chan#e in

(uantity demanded due to a chan#e in the *a"ue o$ any ri#ht hand side

*ariab"e other than own price

%imi"ar"y' we can write the supp"y e(uation as %QsEs7-%P6 3Ss Where'Es is the e"asticity o$ supp"y

Where'Ssrepresents any exo#enous demand shi$t 7 the percenta#e

chan#e in (uantity supp"ied due to a chan#e in the *a"ue o$ any ri#ht

hand side *ariab"e other than own price


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%P* >Sd +SsD5Es+EdD

ote that the denominator Es+EdD is a"ways positi*e' becauseEs is

positi*e andEd is ne#ati*e! ,$Sd ??andSs ?' then %P ??

,$Sd *?andSs ??' then %P @?

,$Sd ??andSs ?? andSd ?Ss' then %P ??

,$Sd ??andSs ?? andSd @Ss' then %P @? Fnce we ca"cu"ate the percenta#e chan#e in price %P' we can

substitute that *a"ue into the demand or supp"y e(uation to ca"cu"ate the

percenta#e chan#e in (uantity demanded or supp"ied

%QdEd7-%P6 3Sd *Ed7 Sd +SsD5Es+EdD3Sd


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eneral ste#s in sol'ing an equili(rium dis#lacement model

"te# 2 2etermine the *a"ues o$ percenta#e chan#e in demand

-Sd

. and supp"y -Ss

.

"te# 9 %peci$y the = chan#es in (uantity demanded and

supp"ied as

%QdEd7-%P6 3Sd

%QsEs7-%P6 3Ss

"te# B %et %Qd %Qs and so"*e $or %P

"te# 4 P"u# the ca"cu"ated *a"ue $or %Pinto the %Qdor

%Qse(uation to ca"cu"ate the percenta#e chan#e in (uantity!


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&Cam#le =' i!e!' Ss +@!>=

There is no chan#e in por demand' i!e!' Sd ?

%uppose that the current price $or por is I1??/cwt and the(uantity bou#ht and so"d is 1'??? cwt per day!

What wou"d be the new e(ui"ibrium price and (uantityJ


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change in #ork #rice and quantity due to the su##ly shift

%P Sd G SsD/EsGEdD ? G -G @!>.D/;!1A G -G 1!HA.D

@!>/@!1? 1!?A=

Thus the por price increases by 1!?A=

%o' the new e(ui"ibrium price wou"d be

P* -1K %P)*P = -1K?!?1?A.LA? A?!A;A/cwt!

%QdEd Sd G SsD/EsGEdD K Sd

= -G 1!HA. ? G -G @!>.D/;!1A G -G 1!HA.D K ?

= -G 1!HA. @!>/@!1? -G 1!HA. 1!?A ;!?A=

Thus the por price decreases by ;!?A=

%o' the new e(ui"ibrium (uantity wou"d be' Q* -1K %Q)*Q

-13 ?!?;?A.L1??? H


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The 4a"ance Tab"e summaries the ey components o$

current3season supp"y and disappearance' a"on# with prior3

season comparisons!

Fundamental AnalysisThe Ealance Ta(le


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%ources: http://www!nass!usda!#o*/Pub"ications/N%tatistics/index!asp

http://www!ers!usda!#o*/data/$eed#rains/Tab"es!aspx

The ba"ance between supp"y and disappearance indicates a season endin#stocs 7 it is the re"ati*e ma#nitude o$ the stocks!to!disa##earance ratio

that is considered the primary price determinin# statistic! Tota" %upp"y 4e#innin# %tocs K Production K ,mports

Tota" 2isappearance 2omestic Ose K Exports

ear Endin# %tocs Tota" %upp"y 7 Tota" 2isappearance %tocs3to32isappearance Ratio -%tocs/2isappearance. 1??

Typica""y' some benchmar ratios are estab"ished $or *arious crops usin#

historica" stocs and disappearance data!

4y comparin# the current year+s stocs3to disappearance ratio to the

benchmar ratio' ana"ysts estimate the price trend 7 direction and extent!

http://www.nass.usda.gov/Publications/Ag_Statistics/index.asphttp://www.ers.usda.gov/data/feedgrains/Tables.aspxhttp://www.ers.usda.gov/data/feedgrains/Tables.aspxhttp://www.nass.usda.gov/Publications/Ag_Statistics/index.asp


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&Cam#les

)or wheat' the benchmar stocs3to3disappearance ratio is typica""y

;?=

,$ the current year+s stocs3to3disappearance ratio $or wheat $a""s be"ow;?=' prices are "ie"y to rise in the comin# months

,$ the current year+s stocs3to3disappearance ratio $or wheat is abo*e ;?='

prices are "ie"y to $a"" in the comin# months

)or corn' the critica" stocs3to3disappearance ratio is typica""y 1;=

)or soybeans' the critica" stocs3to3disappearance ratio is typica""y

1?=

Thus' appropriate tradin# strate#ies can be de*e"oped by comparin# the

current year+s stocs3to3disappearance ratio with the historica"

a*era#es $or di$$erent crops -O%2&.!



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The ba"ance tab"e on"y in*o"*es supp"y and disappearance statistics'

without any direct consideration o$ price 7 thus' may "ead to incorrect

conc"usions!

The tabu"ar and #raphic -T&5. approach examines the re"ationshipbetween the ba"ance tab"e statistics a"on# with prices!

The T&5 method a"so considers other $actors such as the supp"y o$

substitute #oods and income

Osin# the T&5 approach' ana"ysts co""ect and p"ot historica" disappearance

data a#ainst correspondin# prices' and ana"ye the corre"ation! ,nconsistencies are $urther exp"ained by usin# disappearance data $or

substitute #oods!

The T&5 approach is on"y we""3suited to situations in which price

$"uctuations can be "ar#e"y exp"ained by one or two *ariab"es!

Fundamental AnalysisThe Ta(ular and ra#hic 1TA6 A##roach


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Re#ression ana"ysis pro*ides a statistica" procedure that can be used to

$orma"ie the T&5 approach!

)or examp"e' the price prediction e(uation $or ho#s can be expressed as

$o""ows:

The *a"ues o$ the coe$$icients '2'9' andB' can be estimated by

re#ressin# historica" ho# prices on ho# and catt"e s"au#hter data a"on#

with the time trend!

5i*en the estimates '2'9' andB' and proQections $or ho# and catt"e

s"au#hter and the time trend' one can p"u# those *a"ues into the abo*e

e(uation and obtain a precise price $orecast!

Re#ression ana"ysis is probab"y the sin#"e most use$u" ana"ytica" too" in

$undamenta" ana"ysis!

Fundamental AnalysisThe egression Analysis

++++= TimeCattleo!Po! >;1


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Examp"e: 9o# s"au#hter and pi# crop Y = a + bX &ssume that estimates o$ a ?!;>;' and b ?!H;A6!

Y Sune3o* 9o# s"au#hter

X 2ec3May Pi# crop ,$X @6 mi""ion' then Y ?!;>; K?!H;A6@6 @;!8 mi""ion!

&conometric Models

Re#ression ana"ysis emp"oys on"y a sin#"e e(uation! ,n some instances' it is theoretica""y more accurate to construct

mu"tip"e3e(uation mode"s in which the e(uations are interre"ated and

must be so"*ed simu"taneous"y!

%uch mode"s are $re(uent"y re$erred to as econometric mode"s!

Fundamental AnalysisThe egression Analysis


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arious marets exhibit seasona" tendencies!

The concept o$ uti"iin# seasona" patterns in main# tradin# decisions

is based on the assumption that seasona" in$"uences wi"" cause biases in

the mo*ements o$ maret prices!

Ca"cu"atin# a %easona" ,ndex 7 the A'erage Percentage Method Ca"cu"ate an annua" a*era#e $or each year or season

Express each data item as a percenta#e o$ the correspondin# annua"a*era#e

&*era#e the percenta#e *a"ues $or each period! The resu"tin# numbers are

the seasona" index!

Fundamental Analysis"easonal Price


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Fundamental Analysis"easonal Price 8!@

2::: 8!A H!> 11!A 1;!A 1;!1 1;!A 11!; 1?!8 H!6 8!<

9,,, H!1 8!6

9,,2 A!A A!? @!; >!8 @!? A!? A!8 A!6 6!1 6!1 A!6 A!8 ;-9

9,,9 8!> H!? 8!6

9,,B 8!>

9,,4 8!6 8!< H!1 1?!> 1;!@ 1?!@ H!8 H!8 1?!@ 11!> 1?!? 1?!< 2,-29,,; 11!> 11!< 11!6 1;!? 1>!? 1;!H 1>!A 1@!? 1@!8 1>!A 1@!A 1@!< 2B-2

9,,. 1@!? 1@!@ 1@!1 1;!> 11!@ 1?!< 1?!< H!< H!H H!< H!? 8!< 22-9

9,,/ 8!A 8!> 8!< 8!@ 8!8 8!8 8!6 8!H 8!@ 8!1 8-;

9,,8 8!6 8!8 H!? H!A H!@ H!1 8!H 8!8 8!< 8!> 8!A 8!8 8-:


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Mar A#r May Gun Gul Aug "e# )ct Ho' Dec Gan Fe(

2::8 1@8!> 1>;!? 11@!< 1?1!H 1? 86!H 8;!; H?!> 8>!@ 2::: 8@!1 H;!? 11>!8 1;>!< 11H!< 1;>!< 11?!8 1?6!8 HA!? 86!1

9,,, 1@8!? 1>H!8 1;;!? 11

9,,2 1?A!6 H6!? 8?!6 !? 9,,9 11>!6 1;>!1 11!? H@!@ 8>!A H?!> H>!? 88!H HA!8 1?@!?

9,,B 1?6!@ H 1;A!6 1?H!?

9,,4 8@!H 8A!H 8H!H 1?1!< 1;;!A 1?;!< H6!8 H6!8 1?;!< 111!6 H8!8 1?A! 1?;!H 1?6!< 11;!8 1?;!H 11?!A 11;!?

9,,. 1;@!8 1;8!@ 1;A!< 1?H!< 1?1!6 HA!@ HA!@ 86!A 88!> 86!A 8?!; 9,,/ 1??!@ H8!? H;!1 H8!? 1?;!8 HH!; 1?>!H 1?>!H 1?1!6 1?A!1 HH!; HA!= o$ the pre*ious hi#h is ade(uate!

Decline from Peak: The subse(uent dec"ine $rom the second pea shou"d witness anexpansion in *o"ume and/or an acce"erated descent' perhaps mared with a #ap or two!

"u##ort Ereak: 4reain# support $rom the "owest point between the peas comp"etes thedoub"e top! This too shou"d occur with an increase in *o"ume and/or an acce"erated descent!

"u##ort Turned esistance: 4roen support becomes potentia" resistance and there issometimes a test o$ this new$ound resistance "e*e" with a reaction ra""y! %uch a test can o$$era second chance to exit a position or initiate a short!

Price Target: The distance $rom support brea to pea can be subtracted $rom the supportbrea $or a price tar#et! This wou"d in$er that the bi##er the $ormation is' the "ar#er thepotentia" dec"ine!

Technical Analysis

Dou(le To#s
http://stockcharts.com/school/doku.php?id=chart_school:glossary_rhttp://stockcharts.com/school/doku.php?id=chart_school:glossary_r


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Technical Analysis

Dou(le Eottoms


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Prior Trend: ,n the case o$ the doub"e bottom' a si#ni$icant downtrend shou"d be in p"ace!

First Trough: The $irst trou#h shou"d mar the "owest point o$ the current trend!

Peak: &$ter the $irst trou#h' an ad*ance taes p"ace that typica""y ran#es $rom 1? to ;?=!

"econd Trough: The dec"ine o$$ the reaction hi#h usua""y occurs with "ow *o"ume and meetssupport$rom the pre*ious "ow! %upport $rom the pre*ious "ow shou"d be expected! Whi"e exact

trou#hs are pre$erab"e' there is some room to maneu*er and usua""y a trou#h within >= o$ thepre*ious is considered *a"id!

Ad'ance from Trough: o"ume is more important $or the doub"e bottom than the doub"e top!There shou"d be c"ear e*idence that *o"ume and buyin# pressure are acce"eratin# durin# thead*ance o$$ o$ the second trou#h!

esistance Ereak: 4reain# resistance $rom the hi#hest point between the trou#hs comp"etes thedoub"e bottom! This too shou"d occur with an increase in *o"ume and/or an acce"erated ascent!

esistance Turned "u##ort: 4roen resistance becomes potentia" support and there issometimes a test o$ this new$ound support "e*e" with the $irst correction! %uch a test can o$$er asecond chance to c"ose a short position or initiate a "on#!

Price Target: The distance $rom the resistance breaout to trou#h "ows can be added on top o$the resistance brea to estimate a tar#et! This wou"d imp"y that the bi##er the $ormation is' the"ar#er the potentia" ad*ance!

Technical Analysis

Dou(le Eottoms
http://stockcharts.com/school/doku.php?id=chart_school:glossary_shttp://stockcharts.com/school/doku.php?id=chart_school:glossary_s


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6?3


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9ead3and3%hou"ders $ormations are amon# the most $re(uent"y used

technica" patterns $or identi$yin# a price re*ersa"!

9ead3and3%hou"ders $ormations consist o$ $our phases:

The "e$t shou"der The head

The ri#ht shou"der

The penetration o$ the nec"ine

& head3and3shou"der re*ersa" pattern is comp"ete on"y when thenec"ine is penetrated' either in an upward or downward direction! Jead!and!"houlder to#: The $ormation is comp"ete when price penetrate the

nec"ine $rom abo*e indicatin# a re'ersal from a u#trend to a do$ntrend!

Jead!and!"houlder (ottom: The $ormation is comp"ete when price penetrate the

nec"ine $rom be"ow indicatin# a re'ersal from a do$ntrend to an u#trend!

Technical Analysis

Jead!and!"houlders To#s or Eottoms


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Technical Analysis

Jead!and!"houlders To#


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Prior Trend: Without a prior uptrend' there cannot be a 9ead and %hou"ders re*ersa" pattern!

Left "houlder: Whi"e in an uptrend' the "e$t shou"der $orms a pea that mars the hi#h pointo$ the current trend! &$ter main# this pea' a dec"ine ensues to comp"ete the $ormation o$ theshou"der -1.! The "ow o$ the dec"ine usua""y remains abo*e the trend "ine' eepin# the uptrendintact!

Jead: )rom the "ow o$ the "e$t shou"der' an ad*ance be#ins that exceeds the pre*ious hi#hand mars the top o$ the head! &$ter peain#' the "ow o$ the subse(uent dec"ine mars thesecond point o$ the nec"ine -;.! The "ow o$ the dec"ine usua""y breas the uptrend "ine'

puttin# the uptrend in Qeopardy!

ight "houlder: The ad*ance $rom the "ow o$ the head $orms the ri#ht shou"der! This pea is"ower than the head -a "ower hi#h. and usua""y in "ine with the hi#h o$ the "e$t shou"der!

Whi"e symmetry is pre$erred' sometimes the shou"ders can be out o$ whac! The dec"ine $romthe pea o$ the ri#ht shou"der shou"d brea the nec"ine!

Heckline: The nec"ine $orms by connectin# "ow points 1 and ;! ow point 1 mars the endo$ the "e$t shou"der and the be#innin# o$ the head! ow point ; mars the end o$ the head andthe be#innin# o$ the ri#ht shou"der! 2ependin# on the re"ationship between the two "ow

points' the nec"ine can s"ope up' s"ope down or be horionta"!

Technical Analysis

Jead!and!"houlders To#s


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Volume: &s the 9ead and %hou"ders pattern un$o"ds' *o"ume p"ays an important ro"e in

con$irmation! ,dea""y' but not a"ways' *o"ume durin# the ad*ance o$ the "e$t shou"der shou"d

be hi#her than durin# the ad*ance o$ the head! This decrease in *o"ume and the new hi#h o$

the head' to#ether' ser*e as a warnin# si#n! The next warnin# si#n comes when *o"ume

increases on the dec"ine $rom the pea o$ the head! )ina" con$irmation comes when *o"ume

$urther increases durin# the dec"ine o$ the ri#ht shou"der!

Heckline Ereak: The head and shou"ders pattern is not comp"ete and the uptrend is not

re*ersed unti" nec"ine support is broen! ,dea""y' this shou"d a"so occur in a con*incin#

manner' with an expansion in *o"ume!

"u##ort Turned esistance: Fnce support is broen' it is common $or this same support

"e*e" to turn into resistance! %ometimes' but certain"y not a"ways' the price wi"" return to the

support brea' and o$$er a second chance to se""!

Price Target: &$ter breain# nec"ine support' the proQected price dec"ine is $ound by

measurin# the distance $rom the nec"ine to the top o$ the head! This distance is then

subtracted $rom the nec"ine to reach a price tar#et! &ny price tar#et shou"d ser*e as a rou#h

#uide' and other $actors shou"d be considered as we""! These $actors mi#ht inc"ude pre*ious

support "e*e"s' )ibonacci retracements' or "on#3term mo*in# a*era#es!

Technical Analysis

Jead!and!"houlders To#s


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Technical Analysis

Jead!and!"houlders Eottom


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Prior Trend: Without a prior downtrend' there cannot be a 9ead and %hou"ders 4ottom$ormation!

Left "houlder: Whi"e in a downtrend' the "e$t shou"der $orms a trou#h that mars a newreaction "ow in the current trend! &$ter $ormin# this trou#h' an ad*ance ensues to comp"etethe $ormation o$ the "e$t shou"der -1.!

Jead: )rom the hi#h o$ the "e$t shou"der' a dec"ine be#ins that exceeds the pre*ious "ow and$orms the "ow point o$ the head! &$ter main# a bottom' the hi#h o$ the subse(uent ad*ance$orms the second point o$ the nec"ine -;.!

ight "houlder: The dec"ine $rom the hi#h o$ the head -nec"ine. be#ins to $orm the ri#htshou"der! This "ow is a"ways hi#her than the head' and it is usua""y in "ine with the "ow o$ the"e$t shou"der! When the ad*ance $rom the "ow o$ the ri#ht shou"der breas the nec"ine' the

9ead and %hou"ders 4ottom re*ersa" is comp"ete! Heckline: The nec"ine $orms by connectin# reaction hi#hs 1 and ;! Reaction 9i#h 1 mars

the end o$ the "e$t shou"der and the be#innin# o$ the head! Reaction 9i#h ; mars the end o$the head and the be#innin# o$ the ri#ht shou"der! 2ependin# on the re"ationship between thetwo reaction hi#hs' the nec"ine can s"opeup' s"ope down' or be horionta"!

Technical Analysis

Jead!and!"houlders Eottoms
http://stockcharts.com/school/doku.php?id=chart_school:glossary_shttp://stockcharts.com/school/doku.php?id=chart_school:glossary_s


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Volume: Whi"e *o"ume p"ays an important ro"e in the 9ead and %hou"ders Top' it p"ays a

crucia" ro"e in the 9ead and %hou"ders 4ottom! Without the proper expansion o$ *o"ume'

the *a"idity o$ any breaout becomes suspect!

o"ume on the dec"ine o$ the "e$t shou"der is usua""y pretty hea*y and se""in# pressure

(uite intense! The ad*ance $rom the "ow o$ the head shou"d show an increase in *o"ume

Heckline Ereak: The 9ead and %hou"ders 4ottom pattern is not comp"ete' and the

downtrend is not re*ersed unti" nec"ine resistance is broen! )or a 9ead and %hou"ders

4ottom' this must occur in a con*incin# manner' with an expansion o$ *o"ume!

esistance Turned "u##ort: Fnce resistance is broen' it is common $or this same

resistance "e*e" to turn into support! F$ten' the price wi"" return to the resistance brea' ando$$er a second chance to buy!

Price Target: &$ter breain# nec"ine resistance' the proQected ad*ance is $ound by

measurin# the distance $rom the nec"ine to the bottom o$ the head! This distance is then

added to the nec"ine to reach a price tar#et! &ny price tar#et shou"d ser*e as a rou#h #uide'

and other $actors shou"d be considered' as we""!

Technical Analysis

Jead!and!"houlders Eottoms


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Maret trend ana"yses use more comp"ex price charts as we"" as

*o"ume and open interest $i#ures to determine both the existence o$

price trends and the stren#th o$ these trends!

Mo*in# &*era#es Rate o$ Chan#e ,ndicators: Momentum and Fsci""ator

o"ume and Fpen ,nterest

Market Trend Analyses


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Mo*in# a*era#es are used to determine price trends and trend chan#es

& mo*in# a*era#e is a statistica" techni(ue $or smoothin# price

mo*ements in order to identi$y trends more easi"y!

& sim#len3day mo*in# a*era#e is the a*era#e o$ the most recent ndai"yc"osin# prices & A3day mo*in# a*era#e is the a*era#e o$ the "ast A dai"y c"osin# prices!

& ;A3day mo*in# a*era#e is the a*era#e o$ the "ast ;A dai"y c"osin# prices!

The number o$ days used to compute the a*era#e determines the

sensiti*ity o$ the a*era#e to new price mo*ements The more days that are used' the "ess sensiti*e is the a*era#e

Keighted mo*in# a*era#es can a"so be constructed ,$ #reater wei#hts are #i*en to more recent prices' the a*era#e becomes more

sensiti*e to price chan#e


Mo'ing A'erages


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"im#le Mo'ing A'erages 1"MA6


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"im#le Mo'ing A'erages 1"MA6


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%ometimes traders use two mo*in# a*era#es to determine buy and se""

decisions!

Osin# a s"ow mo*in# a*era#e -more days. to#ether with a $ast mo*in#

a*era#e -$ewer days. #enerates the $o""owin# tradin# strate#ies: 4uy when the $aster mo*in# a*era#e #oes abo*e -crosses. the s"ower one

-$rom be"ow.! %e"" when the $aster mo*in# a*era#e #oes be"ow -crosses.

the s"ower one -$rom abo*e.!

4uy when prices are abo*e both the $ast and s"ow mo*in# a*era#es! %e""

when prices are be"ow both the $ast and s"ow mo*in# a*era#es!

&s with most too"s o$ technica" ana"ysis' mo*in# a*era#es shou"d not be

used on their own' but in conQunction with other too"s that comp"ement

them! Osin# mo*in# a*era#es to con$irm other indicators and ana"ysis

can #reat"y enhance technica" ana"ysis!


Mo'ing A'erages Trading strategy


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Rate o$ chan#e indicators' such as momentum and osci""ator indices' are

used as "eadin# indicators o$ price chan#es!

Rate o$ Chan#e -RFC.:

Momentumand )scillatorare based on price chan#es rather than price

"e*e"s' and are used to determine when a price trend is weaenin# or

stren#thenin#' or "osin# or #ainin# momentum!

Momentum


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The elati'e "trength


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Wi"der recommended usin#


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Market Trend Analyseselati'e "trength


100/100

Technica" ana"ysts be"ie*e that *o"ume and open interest pro*ide

in$ormation about whether a price mo*e is stron# or wea! ,$ #ricesare risingand o#en interest and 'olume areincreasing7 new money

is thou#ht to be $"owin# in the maret' re$"ectin# a##ressi*e new buyin# 7

Eullish

,$ #rices arerisingbut 'olume and o#en interest aredeclining7 the ra""y is

thou#ht to be caused primari"y by short co*erin# 7 money is "ea*in# rather than

enterin# the maret 7 the uptrend wi"" probab"y end once the short co*erin# is

comp"ete 7 Eearish!

,$ #rices arefallingbut 'olume and o#en interest are rising7 new money isthou#ht to be $"owin# in the maret 7 re$"ectin# a##ressi*e new short se""in# 7

the downtrend wi"" probab"y continue 7 Eearish

,$ #rices are falling and 'olume and o#en interest are declining 7 the price

Market Trend AnalysesVolume and )#en

fundamental and technical analysis of commodity

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