There are some asset classes that folks simply put in the too-hard basket. That’s because they can be choppy and quite difficult to trade.

Take commodities, for example. You only need to see the chart of the Invesco DB Agriculture Fund (DBA) lower down to see what I mean.

It’s an ETF that holds positions in a broad range of commodities like sugar, cocoa, coffee, corn, meats, wheat, and cotton. And DBA bounces around all over the place…

This type of action puts people off. But all those moves and countermoves can be highly profitable. You just need to know how to trade them.

So today, let’s examine two technical tools that can help you navigate these kinds of situations. Better still, you can also apply them to many trading scenarios…

Spotting Potential Reversals

In the DBA price chart below, I’ve included Bollinger Bands. This is a great tool to help determine when a stock is trading at the extremes of its trading range… and could be vulnerable to a reversal.

So it plays right into my mean reversion strategy…

Invesco DB Agriculture Fund (DBA)

Source: e-Signal

The upper and lower bands (blue lines) are set at two standard deviations from the mean (orange line). That means around 95% of the price action will occur between the blue lines.

The bands stretch wider during periods of higher volatility… and they converge when volatility is falling.

But while Bollinger Bands can help gauge volatility, they can also help find potential changes in direction. When prices start trading near either of the extremes (blue lines), that increases the chances that they will swing back the other way.

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 reversals A through H. Notice that DBA reversed off the upper blue line. Take another look at the chart:

Invesco DB Agriculture Fund (DBA)

Source: e-Signal

Yet we shouldn’t blindly short a stock because it’s tracking along the upper blue line. Just because a stock is trading along a Bollinger Band doesn’t mean it’s guaranteed to reverse… We need confirmation.

That’s where the Relative Strength Index (RSI) fits into the picture…

Extra Confirmation

If you match up those peaks with the RSI at the bottom of the chart, you can see that they coincided with the RSI reversing lower.

Now look at the gray arrows in the bottom part of the chart. The RSI forming a ‘V’ and rallying higher also coincided with DBA rebounding higher from its lower Bollinger Band.

The trick is to use both indicators together…

By combining Bollinger Bands and the RSI, we’ve greatly increased our chances of catching a reversal and setting up a profitable trade.

Ideally, we look for the RSI reversing from overbought (70% or higher) or oversold territory (30% or lower). And we try to catch a swing in momentum when a stock is trading at either the upper or lower Bollinger Band.

By combining Bollinger Bands and the RSI, you’ll greatly improve your chance of banking profits.

Happy Trading,

Larry Benedict
Editor, Trading With Larry Benedict