The ability to make commodity price forecasts is only the first step in the price decision making process. The second, and often more difficult step, is market timing. Since commodity futures markets are so highly leveraged ( initial margin requirements are generally less than 10% of a contract's value), minor price moves can have a dramatic impact on trading performance. Therefore, the precise timing of entry and exit points is an indispensable aspect of any market commitment. Timing is everything when dealing in the commodities markets, and timing is almost purely technical in nature. This is where a practical application of charting principles becomes absolutely essential in the price forecasting and risk management process.
There are three basic assumptions on which technical analysis is based:
1. The futures market discounts everything.
The technician believes that the price posted on the board of a commodity exchange at any given time is the intrinsic value of the commodity based upon the fundamental factors affecting the supply and demand of the product. Therefore, if the fundamentals are already reflected in the price, market action (charts- price, volume, open interest) is all that is needed to be studied to forecast future price direction. Although not knowing the specifics of the fundamental news, the technician indirectly studies the fundamentals by studying the charts which reflect the fundamentals of the marketplace.
2. Prices move in trends
Prices can move in one of three directions, up, down or sideways. Once a trend in any of these directions is in effect it usually will persist. The market trend is simply the direction of market prices, a concept which is absolutely essential to the success of technical analysis. Identifying trends is quite simple; a price chart will usually indicate the prevailing trend as characterized by a series of waves with obvious peaks and troughs. It is the direction of these peaks and troughs that constitutes the market trend.
3. History repeats itself
Technical analysis includes the psychology of the market place. Patterns of human behavior have been identified and categorized for several hundred years and are repetitive in nature. The repetitive nature of the marketplace is illustrated by specific chart patterns which will indicate a continuation of or change in trend.
You probably remember back in high school, watching your teacher solve a complex algebra problem with ease. Although you took notes, trying to complete the homework assignment was a challenge. How did the teacher make something so complex seem so easy? You were both using the same formula, the same methodology, and the same computations. However, while you struggled, she did it with ease and elegance. What was the difference? Continue reading here.