DROZD: Canola charts gave early indications of a downturn

With a record canola crop in the making, producers should be taking measures to manage their pricing risk

The price of canola on the nearby weekly futures contract has declined $178 per tonne or the equivalent of $4 per bushel since May 2013. With basis levels deteriorating, cash prices have fallen further — as much as $5 per bushel.

Tight ending stocks at the end of the 2012-13 crop year and reduced acreage for 2013-14 had starry-eyed bulls looking for higher prices. It’s not unusual to hear bullish news at the top of a market, but this unfortunately causes some farmers to hold off selling in anticipation of higher prices.

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Technical analysts rely on charting to cut through the news (noise). Charting and technical analysis are proven methods of catching a turn in the market, especially when the news is incredibly bullish. It is important to note that despite a market’s fluctuations, prices are often contained between areas of resistance and support.

Support and resistance

Support and resistance are terms used to describe a price level where the buying or selling of futures contracts is expected to noticeably increase and at least temporarily halt the current direction of the market. These areas appear as well-defined price ranges within which the market will fluctuate. The greater the amount of time spent and the number of contracts bought and sold in this range, the greater will be the potential for support or resistance in the future.

A specific example of prices rallying into an area of resistance appears as (A) in the accompanying chart. Occurrences such as these are commonplace on futures charts and are extremely important, as they illustrate where future rallies and declines are likely to fail. Support and resistance levels define the parameters of the major trend.

Market psychology

Support and resistance areas evolve because equilibrium is reached between buyers and sellers. The market attracts buying around the bottom of the range and selling in the top portion. If prices break down through the lower boundary (B), then all recent buyers are holding losing positions. Any return move back to this zone (C) subsequently represents an area in which to liquidate a long position at break-even or with a reduced loss.

Those who sold in the upper portion (A) of the trading range now have profits and may utilize the rally (C) to sell more contracts.

The concept of support/resistance and the market’s reaction when it moves into a support or resistance area are among the most interesting facets of chart study. Where a classic formation may not appear on a chart for several months, one can be reasonably sure that there is always a support or resistance area not very far from the market. This is important because it can help one formulate expectations of future price action.

It is important to watch for reversal patterns when prices are challenging key areas of resistance. As illustrated in the accompanying chart, a two-week reversal developed when prices were challenging the stiff area of resistance at $650 per tonne.

A two-week reversal indicates a change in trend and exemplifies a sudden change in sentiment. On the first week the longs were comfortable and confident as the market closed higher and their expectation was for the market to have further gains.

However, the second week’s activity is a complete turnaround from the preceding week and quickly erodes the confidence of those who are still long the market. The longs respond to weakening prices by exiting the market. This is referred to as long liquidation and regardless of how bullish the news may be, it is often responsible for the sudden shift in a market’s dynamics and subsequent sell-off.

The fundamental news didn’t become bearish until $650 was a distant memory. Declining vegetable oil prices and record canola yields across all three Prairie provinces have been weighing on prices. With a record canola crop in the making, producers should be taking measures to manage their pricing risk.

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