Energy Matters: Technical Analysis
Your Energy Manager
Topic: Technical Analysis
April 2007
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Independent Energy Consultants, is committed to helping its clients make well-informed and cost-effective decisions regarding their energy supply and consumption. We are sending you this newsletter to help you understand how energy decisions that are made, or not made, effect your company's bottom line.

If you have ever bought stocks, options, futures, or had someone do it for you, there's a good chance that technical analysis was performed to aid in that decision. The term Technical Analysis, while broad in scope and often complex, always boils down to the manipulation of historical price and volume data, often in the form of charts and/or mathematical formulas, to help predict future prices. In this month's newsletter we will scratch the surface of technical analysis. Anyone interested in learning more is encouraged to read one of the many books on this subject, or attend a seminar to hone their skills.

There are numerous methods for performing technical analysis and new ones seem to come out every day. You may have heard of trading methods and tools, or seen them on your favorite cable news channel that involve:
  • Moving Averages
  • Stochastics
  • Bollinger Bands
  • Point and Figure Charting
  • Elliot Wave
  • Relative Strength Indicators
  • Fibonacci Numbers
  • Candle Stick Charting
  • Momentum Indicators
Each method can provide value when properly understood, applied, and used in conjunction with a sound knowledge of market fundamentals. If polled, I believe most professional commodity traders would agree that it's best to employ several techniques to confirm buy/sell/hold signals. The challenge is to find a system that works for you without creating clutter that turns valuable information into mere data.

Before we go any further, we want to stress that the use of technical analysis does not guarantee success and is not an excuse to forgoe sound risk management techniques such as the use of stop-loss orders. Trading is like baseball - no player ever bats a thousand. We are merely encouraging the use of valuable techniques to help improve your chances of making good decisions. At Independent Energy Consultants we understand that good decisions based on sound reasoning and the best available information do not guarantee good outcomes. They do, however, increase your odds of success. Conversely, we acknowledge that from time-to-time poor decisions turn out good. We call the latter luck, and realize that for every lottery winner there are thousands of losers.
The technical analysis methods employed should always match the goals you are trying to achieve, the time span under consideration and your risk tolerance. For example, with the power of today's personal computers and the Internet, a day trader might make several buy/sell transactions over the course of an hour. That individual would be looking for commodities with volatile price movement and could be focused on price ticks and 5-minute moving average charts. Furthermore, if profit is his/her only motivation, they have no pressing need to make any trades if conditions aren't favorable.

Now let's contrast that with the procurement manager of a manufacturing facility that consumes large amounts of natural gas in its production process. Those individuals are forced to buy natural gas and are likely seeking a combination of competitive prices and price certainty. Their time horizon may stretch out ten years. In that case they could be looking at moving averages of 10 weeks or more and looking at seasonal effects.

In either case, both decision makers would be wise to start with a long-term technical analysis. Once again, for the day trader long-term might be several days and for our purchasing manager it could be several years. The objective at this stage is to identify the underlying long-term trend. A time-honored saying amongst traders is "the trend is your friend". Once you have identified whether you are in a bull, bear or sideways market, you can start to overlay shorter-term indicators that can help identify when and where trend changes are likely to occur. For our purchasing manager this might mean adding a 7-week moving average chart to his 10-week moving average chart. A challenge for any technical analysis is the fact that you are using lagging indicators to predict future price behavior. The danger is that by the time the indicator has changed directions, the buying or selling opportunity may have passed. There are techniques to address that issue, but it is beyond the desired scope of this newsletter.

As part of our daily analysis of the energy futures' market Independent Energy Consultants uses technical analysis to identify key trading parameters for a number of energy contracts. For example. Analysis performed on 4/23/07 of the May 2007 NYMEX Natural Gas Futures Contract revealed:
  • Settle price of $7.589/MMBtu
  • First major support to slow declining prices exists at $7.359/MMBtu
  • Pivot point where the consensus buy trend changes to a sell signal $7.587/MMBtu, and
  • The first major resistance to slow rising prices exists at $7.815/MMBtu
Note how close the day's closing price is to the pivot point. This indicates that we have a very weak buy signal being generated. This is to be expected as the May contract has been trading sideways for the past two months.
When performing technical analysis pay close attention to the scales used to display data. As previously mentioned a chart's time scale can show price movement in increments ranging from minutes to months. Log scales can also be used to compress information. Moving averages calculated from those prices can use different time periods. Furthermore, trend lines can be calculated from simple averages or exponential averages if the user is attempting to eliminate "noise" that may lead to knee-jerk trading decisions.

Even the most casual user can easily pick up the basics. One should know that technical charts can be manually modified to determine points of price support by drawing straight lines between trading lows. Similarly, points of resistance can be found by drawing lines between previous highs. Bar charts will use vertical lines to show the day's high and low prices with crossing horizontal lines to show the opening and closing prices. Depending on the charting service, the popular Candle Stick charts will be solid or left blank to distinguish between up and down days. Other vendors color code the sticks to reveal the same information. As you gain experience and find charts that fit your eye, you will be able to spot price formations that shout "something could be happening here". Those patterns have names like, head and shoulders, double bottom, cup with handle, etc. Once again, technical analysis can be complex, but doesn't have to be overwhelming. We encourage our clients to familiarize themselves with the concepts and learn to become comfortable with a technique that fits their time frame, objectives, and risk tolerance. The "area chart" above provides a simple but helpful analysis of the NYMEX natural gas chart for the current 12-month contract. The chart was obtained from FutureSource.com. Let's point out a few observations:
  • The historical prices for a 12-month strip of natural gas are shown by the top of the blue shaded area. The most recent price is $8.601/MMBtu.
  • The black downward sloping line connecting the prior trading highs shows were resistance will be met to slow rising prices.
  • The red and blue lines enveloping the price movement are Bollinger Bands. They are calculated from the prior 20 days prices and 2 standard deviations up and down. Do not let the math scare you, the calculations are done for you. You should, however, note how prices tend to bounce when they touch these bands.
  • The green line is the simple moving average. Note how the current trading price is right at the average. This indicator, if used by itself, would say there is not a strong trend either up or down. And finally,
  • Late September and December presented excellent buying opportunities for those wishing to hedge some or all of there upcoming natural gas needs.

Contact Independent Energy Consultants for help with your energy purchases, and all your energy management needs.

email: info@naturalgas-electric.com
phone: (330) 995-2675

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