Momentum Trading in Commodity Markets Using Technical Indicators

Momentum strategies, a prevalent trading approach, have also found applicability within commodity markets. These strategies capitalize on the observed tendency of assets to continue their existing trends in the short term, either upward or downward. In commodity markets, momentum strategies involve buying or selling commodities based on their recent price trends, aiming to capture price continuation patterns. This approach relies on the assumption that price trends in commodities can persist due to factors such as supply-demand imbalances, macroeconomic influences, and investor sentiment.

Reference [1] investigated momentum trading strategies within the commodity market. It employs two technical indicators, RSI (Relative Strength Index) and MACD (Moving Average Convergence Divergence), to assess momentum and create a long-only portfolio using these indicators. The authors pointed out,

The authors conclude that there are several factors bearing responsibility to the failure of the MACD indicator. To exemplify, a factor could be that MACD works better in shorter time frames and should be utilized to both short and long the positions in a portfolio. Furthermore, MACD is calculated by subtracting a shorter EMA from a longer EMA. In this thesis the short EMA was set to 12 days and the long EMA was 26 days. Experimenting with these parameters adjusted to the commodity futures market could have benefitted the results and potentially produced superior results.

In short, MACD is not a good indicator for this type of momentum trading. RSI, on the other hand, proved to be a better performer,

Furthermore, the findings of this thesis produced highly favorable results during single utilization of the RSI, even superior to the joint-use portfolio. The success of said indicator can partly be explained by its strong capabilities to detect upcoming bearish and bullish market conditions. For instance, values around or below 30 indicate oversold conditions, through a contrarian approach the authors would go long when RSI values reached this point. Subsequently, the quarterly performance revisions provided enough time for the commodities to break out of oversold conditions and yield favorable results. A quarterly contrarian strategy based on opposite momentum movements can thus be concluded to have a positive effect in portfolio construction.

We acknowledge the research's potential validity in terms of employing technical indicators for momentum trading. However, it is noteworthy that the study lacks robustness tests. Specifically, the arbitrary selection of overbought/oversold thresholds and the absence of examination and discussion on the parameters used for indicator calculations raise concerns about the research findings.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Jino Badinson and Alfred Gunnarsson, Momentum Strategies in Commodity Futures Market: A Quantitative Study, 2023, Umeå School of Business, Economics and Statistics

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