Drozd: A “two day reversal” alerts livestock producers to hedge meal

Soybean meal prices have rallied $42 per ton over the past few weeks. On June 9, 2010 technical analysis signaled traders and livestock producers alike to expect prices to turn back up.

Technical analysis is the study of market movement. Its strength and popularity comes from the explicit assumption that future price direction can be predicted by studying a market’s past activity. 

In technical analysis no consideration is given to daily news developments, supply and demand factors, government reports or policies. Over the longer term, major changes in supply-demand relationship and in government policies do, in fact, determine the direction of futures prices. 

However, over the short and intermediate term technicians argue that this is a formidable task requiring almost perfect knowledge which renders fundamental price forecasting (at least for the short term) an exercise in futility. Technical analysis is committed to the theory that the market itself simply and efficiently discounts all fundamental factors each and every day.

Price charts provide what may be the oldest and easiest means of observing and studying market movements.

The chart is studied for the development of patterns which have been proven to predict price direction. Each day’s prices and the pattern configurations which develop over time are the direct result of human decisions to buy and sell. Studying the price movement and patterns therefore is an indirect examination of human nature in the marketplace. Since human nature does not change, it becomes reasonable to expect that behavior as reflected by price formations on the chart will repeat.

In essence there is nothing new in the market’s movements which hasn’t already occurred in the past and will not reappear in the future. A primary objective in using charts is to familiarize oneself with these patterns and to recognize them when they begin to take shape.

If one is going to undertake a study of charts, it is imperative to learn the signs and what their implications are for prices. That may sound easy, but chart reading is an art rather than an exact science and more often than not there’s plenty of leeway for personal interpretation. Everyday experience and a study of historical charts are important, but even then there are many times when one simply does not know until after the fact.

Reversal patterns develop at the end of an existing trend and indicate a change in trend just like this two day reversal did in the accompanying chart.

Two-day reversal

On the first day, (at a bottom) the market advances to new lows, but closes very weak at or near the low of the day. The following session, prices open unchanged to slightly lower but cannot make additional downside progress. Quantity buying appears early in the day to stymie the decline and prices begin to advance. By day’s end, the market rallies to around the preceding day’s high and closes at or near that level.

Market psychology: The two day reversal indicates a change in sentiment. On the first day, the shorts are comfortable and confident. The market’s performance provides encouragement and reinforces the expectation of greater profits.

The second day’s activity is psychologically damaging. It is a complete turnaround from the preceding day and serves to destroy or at least shake the confidence of many who are still short the market. The immediate outlook for prices is abruptly put in question. Shorts respond to strengthening prices by exiting the market and this causes prices to move back up.

Just as this two day reversal provided farmers with an opportunity to hedge their meal needs before prices rallied, another could indicate when the rally is over.

Join me online at www.Ag-Chieve.ca/cooperator/ for an audiovisual presentation about this article and chart.

— David Drozd is president and senior market analyst for Winnipeg based Ag-Chieve Corporation. The opinions expressed are those of the writer and are solely intended to assist readers with a better understanding of technical analysis in the markets influencing agriculture. The information contained herein is deemed to be from sources that are reliable, but its accuracy cannot be guaranteed. Visit us online at www.ag-chieve.ca/cooperator/ for more grain marketing ideas and educational tools, or call us toll free at 1-888-274-3138 for a free consultation.

About the author

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David Drozd is president and senior market analyst for Winnipeg-based Ag-Chieve Corporation. 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 at www.ag-chieve.ca for information about our grain-marketing advisory service and to see our latest grain market analysis.

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