Hot Commodities: Prices Go Parabolic!

Gold, grains, and even crude oil prices overnight are rising rapidly. Commodities prices are accelerating skyward! They are changing from red hot... to white hot!

The headline in the graphic above is from an article from the Washington Post, and you can read it by clicking on the graphic, which I have linked to the article at the Post.

Is there anything that isn't rising in price? Yes! The U.S. Dollar is "being slammed today," in the words of CNBC futures reporter Rick Santelli. And as the USD continues to move down, commodities prices will continue to move higher, creating inflation.

Statistical Analysis + Technical Analysis = Bollinger Bands

I must confess, however, that I am a little anxious about this. Usually, when prices rise so rapidly in such a short period, sharp corrections are likely. Many commodities appear somewhat overbought to me on a temporary basis. I would expect that prices may correct or consolidate before another rise. I could be wrong, but historically and statistically, when prices move beyond two standard deviations of the bell curve from the mean (meaning outside the Bollinger Bands), a correction or consolidation increases in statistical probability.

When prices move outside three standard deviations from the mean, as has occurred in recent days with some of the most popular commodities, then the likelihood of a correction increases. In the case of three standard deviations, the statistical probability of a sharp correction becomes much more likely than a simple consolidation. I have no idea how much longer these parabolic prices increases will continue, but the longer they do, the more likely that a sharp pull-back will occur to return prices to within the statistical probability typical for the financial markets.

From a statistical standpoint, when prices go parabolic in their rise, it is highly probable that prices will correct or go stagnant for a period. When prices move outside the Bollinger Bands for an extended period, then prices are subject to sharp corrections or consolidation until the market can absorb new price levels and adjust to the higher levels.

Psychology of Market Madness and Manias

Part of the reason for this may be psychological. When prices move so far outside the accepted norm, then traders begin to think that they are unreasonable and overbought. They may then begin to sell them, or if they are overextended, they may be forced to cover those positions by selling as their positions begin to take a loss. I like to study mass market psychology and historical manias. Perhaps the classic book on the subject is "Extraordinary Popular Delusions and the Madness of Crowds" by Charles MacKay. Another good one, but less known, is "Confusion de Confusiones" (English translation) by Joseph de la Vega. Understanding these "delusions" and "confusions" is wisely always in the back of the minds of good traders. Using these psychological undercurrents against other traders, and understanding why they occur, gives traders one additional edge against the markets in trading. If you, dear reader, know of additional books on the subject of market psychology, and would like to recommend one, please contact me.