Wheat prices recently rallied over $3 per bushel in as little as six weeks on speculative buying and short covering. Farmers are now wondering when the rally will end.
Technical analysis is very useful for determining current trends and trend changes. Some analysts rely on moving averages and others simply draw trendlines. Here is an explanation on how to properly construct and use trendlines.
During the course of a trend and all the fluctuations which compose it, there is a well observed characteristic for prices to closely follow a sloping straight line path. During a period of rising prices, this path is determined by a line drawn across the lows of the reactions.
One can confidently establish that a trend is in progress using trendlines and the aid of some general rules. When an emerging trend can be identified and followed to its conclusion, it translates into opportunity. The use of trendlines is a valuable tool for accomplishing this.
For a trendline to be both valid and reliable in a rising market there should be at least three points of price contact, each of which coincides with the low of a market reaction.
These price reactions must bottom at progressively higher levels. Beyond the minimum of three contact points, the more times a trendline can check a price decline in a bull market the more valuable it becomes as a trend indicator. Similarly, the longer the trendline continues without being penetrated, the greater becomes its technical significance.
After a bear market decline, a tentative uptrend line may be constructed after two bottoms have formed, the second at a higher level than the first. If a third bottom forms at this line, then the minimum requirement of three contact points is met and the line can be considered valid provided prices begin advancing from the third bottom.
Once a trend begins in earnest, it has a high tendency to persist. Thus, a properly constructed trendline may be touched several times by the fluctuating market during the course of big move without being penetrated. The longer the trendline endures, the more significant becomes its eventual penetration as an indicator of trend change.
However, a price violation of the line is not enough to conclude that the trend has turned. At the very least, the market must close decisively beyond the line. After a valid penetration, prices will move with an initial thrust in that direction and will sometimes turn back to approach the trendline.
The probability of a valid trend turn is increased when a number of technical events occur at or near the same point in time. Penetration of a trendline may coincide with the completion of a reversal formation.
As a new uptrend begins to emerge, buy orders materialize, but many are at a limit price under the market. In the normal ebb and flow of the market some of this buying is satisfied on price declines. A portion of the demand, however, is not satisfied and when prices again begin to move up, some of these buyers jump in for fear of missing the move. The balance of unfilled buying will continue to trail the market in hopes of catching a price reaction. Most of these buyers will gradually increases their bids as the market advances.
When the price finally does turn down for real, trendlines will be quickly broken because the demand has either been totally satisfied or the volume of selling simply overpowers what little buying remains.
The current trend is up as long as wheat prices remain above the trendline in the accompanying chart.
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