Drozd: Reversal pattern alerted producers to cattle price downturn

Cattle prices have been sliding lower, since a two-week reversal developed in early April. This reversal pattern identified a quick halt to the rally after cattle prices climbed to an unprecedented historical high of $122.875.

Two-week reversal

This chart formation indicates a change in direction and can occur at the top or bottom of a market. This two-week reversal is especially prominent because it materialized at a new high for the move. On the first week, the market established a new high for the recent rally and closed very strong at the high of the week.

Prices opened slightly higher the following week, but failed to make additional upside progress as increased selling occurred early in the week and prices began to turn back down. By week’s end, the market dropped and settled around the preceding week’s low. Follow-through weakness verified the reversal pattern.

Market psychology: The two-week reversal identifies a complete change in market outlook. In the first week, the longs (market participants who had purchased a futures contract on the expectation of higher prices) are content with their long positions. The market’s performance is encouraging and validates its outlook for greater profits.

The second week’s activity takes its toll on traders as it’s a complete turnaround from the preceding week and without a doubt shakes the confidence of those who are still long the market. The immediate outlook for prices is abruptly put in question, so longs respond to weakening prices by exiting the market. Some sell to protect profits and others sell to cut their losses.

This increased selling accelerates the drop in prices. This was evident when prices gapped lower through the lower boundary (A) of the uptrending channel.

Gaps

Gaps are areas on the price chart where no trading has occurred. The gap (A) illustrated in the accompanying chart is the result of the market opening lower, so it’s described as a downside gap.

This particular gap is referred to as a breakaway gap because it materialized soon after the completion point of the reversal formation. Its appearance provides additional confirmation of the two-week reversal pattern’s validity. Seldom will prices fail to do what is expected when pattern completion is followed by a breakaway gap.

This breakaway gap was especially significant for predicting additional weakness because it occurred as prices broke below a major line of support, which was the lower boundary (A) of the uptrending channel.

The penetration of this trendline is a particularly strong indication of a trend change of at least intermediate proportions because following a top formation, in which an uptrend line of significant duration has been decisively penetrated by the price gapping away from both the trendline and pattern, thus forming a breakaway gap — well, it just couldn’t be better technically.

In short, the probability of a valid trend turn is increased when a number of technically significant events occur at or near the same point in time.

If you’re getting the notion that you must constantly search the charts for as many clues as possible, you’re absolutely right. The more evidence one can muster to support a technical conclusion, the more reliable that conclusion is apt to be.

Just as the charts gave traders an insight that cattle prices would realign to a new higher trading range, the fundamental long term outlook for cattle prices has grown more positive due to herd liquidation.

However, just as technical analysis forecasted the recent downturn in prices, the short term fundamental factors have grown bearish since the cool wet weather delayed the onset of the barbecue season.

Cattle prices have a seasonal tendency to firm up in the summer when demand returns and the present buildup of boxed beef is drawn down.

Send your questions or comments about this article and chart to [email protected].

— David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corp. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis. Visit Ag-Chieve online for information about grain marketing advisory services, or call us toll free at 1-888-274-3138 for a free consultation.

About the author

explore

Stories from our other publications