After a two-year rally, the Invesco DB Agriculture Fund (DBA) peaked in May last year. But then it rolled over and headed lower.
As a reminder, DBA holds positions in commodities like sugar, cocoa, coffee, corn, meats, wheat, and cotton.
By the time DBA bottomed out in January this year, it had fallen around 16% below its May 2022 high.
And it was trading over 12% lower than at the start of the Ukraine invasion.
DBA has been grinding higher since then. But there have been plenty of swings along the way.
This type of zigzagging action might put some people off. But that’s leaving potential profits on the table.
So today I want to show a technical tool that can help you navigate (and profit) from these kinds of situations.
A Tool for Spotting Potential Reversals
On the upper half of the chart below, we’ve included Bollinger Bands. This is a great tool for determining when a stock is oversold or overbought.
Invesco DB Agriculture Fund (DBA)
Source: eSignal
The upper and lower bands (blue lines) show the typical price movement a stock can expect. Statistically speaking, roughly 95% of the price action will appear between these two lines.
The bands tend to stretch wider during periods of higher volatility. And they come closer together when the price isn’t seeing much movement.
And the middle orange line is the 20-day moving average (MA). As you can see, it has been climbing since January of this year.
So Bollinger Bands can help gauge volatility. Yet they are also useful for finding potential changes in direction.
And that’s what I want to focus on today.
When prices start trading near either of the two blue lines, prices will likely start swinging back the other way.
And that fits right into our mean reversion strategy. Remember, when stocks stretch too far in one direction, they tend to “snap back” like a rubber band. And we can profit by anticipating those moves.
Look at the rallies up to each of those higher highs.
At “1” through “5,” you’ll notice that DBA tracked along the upper blue line for an extended period before it reversed. The exception is “4,” which was briefer.
Take another look:
Invesco DB Agriculture Fund (DBA)
Source: eSignal
So if we just shorted DBA when it first traded at the upper Bollinger Band, we likely would have lost money in any potential trade.
That’s where the Relative Strength Index (RSI) in the bottom half of the chart can help spot potential reversals more precisely…
DBA’s peaks and reversals from “1” through “5” coincided with the RSI forming a peak and reversing (red circles) from overbought territory (upper gray dashed line).
By using both the Bollinger Bands and the RSI together, we could have greatly increased our chances of success with any short trades.
It’s a similar story with each of DBA’s troughs.
Each of DBA’s higher lows saw it rallying off the lower Bollinger Band. Similarly, the RSI formed a “V” and rose from near-oversold territory (lower gray dashed line).
So with DBA now tracking on its lower Bollinger Band, what am I expecting from here?
Free Trading Resources
Have you checked out Larry’s free trading resources on his website? It contains a full trading glossary to help kickstart your trading career – at zero cost to you. Just click here to check it out.
Extra Confirmation
Just because a stock is trading along the upper or lower Bollinger Band is no guarantee that it will reverse.
So using the RSI as well can help us better identify a potential change in direction.
And that’s what I’ll be watching from here…
If the RSI forms a “V” and bounces from (or near) oversold territory, we’ll check DBA to see if it’s also rallying off the lower blue line.
That could provide the setup for a potential long trade.
Note, though, that we’re not necessarily looking for a change in the overall broader trend…
Instead, we’re looking for a stock that has overshot in either direction. We then use our technical tools to profit when it snaps back the other way.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
P.S. If you want to learn more about one of my favorite trading strategies, then be sure to tune in at noon today to my 8-Hour Windfalls event. This will be a rare opportunity to follow me around for a day, see my trading in action, and learn how you can bring in profits in 8 hours or less… To make sure you don’t miss a thing, you can go right here to automatically reserve your spot to watch for free.
Mailbag
Do you plan to apply Bollinger Bands and the RSI to your personal strategy? Let us know at [email protected]