Businesses and people often get involved price forecasting in the futures markets, since virtually all market behavior and pricing decisions are based upon expectations for future prices. For example, a corn farmer may expect declining prices due to favorable weather conditions during the growing season. As such, he will likely hedge his crop in order to lock in a price for his corn when he is ready to bring it to the market.
The price of a given futures contract reflects the information available in the market, the expectations for future price movements, and the overall psychology of the market. There are generally two approaches to market analysis: fundamental analysis which considers supply and demand, and technical analysis which is the analysis of price movements in the market. We compared these two analyses in a previous article here.
Market technicians study price movements with the hope that they can develop price based indicators capable of forecasting future price movements. Market technicians do not pay any attention to supply and demand factors that may influence price. They feel that the current price is reflective of information currently available regarding supply and demand.
The basic tool of the market technician is the price chart. The typical price chart provides information regarding the daily prices of a given market, including the high, low and closing price of each day. This is presented in the form of a bar chart. Starting from the left side of the chart, a bar is added each day. The size of the bar for each day is determined by the price range for that particular day. At the bottom of the bar chart you will often see bars that represent the volume of contracts traded for each trading day.
Market technicians often look for price patterns on their charts that may give them a clue about future price direction. They will identify patterns such as resistance areas, support areas, key reversal days, head and shoulders patterns, double tops and bottoms, gaps, triangles, wedges and flags. These patterns are studied and categorized as reversal patterns or continuation patterns to help the technician identify future price movement.
Technicians may also employ indicators that are derivatives of price, such as moving averages, stochastics, oscillators, etc. These indicators help to identify the current trend in the market, and areas where the technician, or trader, can identify a potential reversal in the trend.
In the futures markets, technical analysts will also study price, volume and open interest relationships. For instance, a market that is increasing in price with increasing volume and open interest is bullish. Increasing volume and open interest suggests there is buying pressure in the market, and this should lead to higher prices. On the other hand, a market where prices are increasing, but volume and open interest are declining is bearish, because buying pressure is drying up.
Technical and quantitative analysts will often attempt to develop mechanical trading systems based upon price patterns, or relationships between price, volume and open interest. These systems are an attempt to take the emotional aspects of trading out of the equation. A trader can simply plug in a formula and have a computer generate trades based upon this mechanical system. A simple example is a moving average system. When the price moves above the moving average from below, the trader covers his short positions and buys long. When the price moves below the moving average from above, he exits his long position and enters a short position. Combining this mechanical entry and exit strategy with sound risk management can lead to long term profits.
This is just a basic discussion about technical analysis. There are many books on the subject that are worth reading, and it is highly recommended that any beginning trader gain a thorough understanding of technical analysis before trading in the futures markets.