Drozd: Soy prices rebounded after achieving double top objective

The soybean market has been under pressure, since prices peaked at a new historical high of $17.94-3/4 on Sept. 4, 2012.

This market has been under the influence of long liquidation for the past three months. Given the fundamental situation, some traders may be bewildered by the market’s weakness, while those who study charting and technical analysis were patiently waiting for the market to achieve the double top objective of $14.18 per bushel.

This objective was achieved on Nov. 12 and is derived from measuring the distance between the reaction low (A) ($16.02) and the two highs (B) ($17.86). This value is then extrapolated under the reaction low to arrive at a new objective ($14.18).

Double tops are basic formations which appear with regularity in the futures markets. Once completed, they provide a reliable indication of a trend reversal.

A double top begins to take shape with prices advancing into new high ground for the current move. A reaction then sets in during which a portion of the advance is retraced, which I’ve identified as point “A” in the accompanying chart.

A second advance brings prices back up to approximately the highs of the first advance, followed by a price decline, which eventually drops below the reaction low (A).

Time-wise, it is important that the two tops are not very close together. If they are, what’s more likely to be happening is a normal consolidation of the existing trend.

Often at a top, the second advance will slightly exceed the first top and appear very pronounced or spiked. However, it could also fall shy of the first top.

This formation is completed when, after a double top, prices fall beneath the reaction low that occurred between the two tops.

Market psychology: The first top develops after a sustained price rise. It will coincide with a growing willingness on the part of longs with large unrealized profits to cash in their earnings.

The market stalls or at the very least starts losing upside momentum. The supply of contracts for sale exceeds the demand and the market turns down. Short sellers jump in convinced that the upward move has gone far enough.

A reactionary phase ensues during which ownership of contracts continues to change hands. Old longs exiting with their profits are replaced by new longs. The market continues to decline until the price drop causes sellers to withdraw.

From a longer-term perspective, the bull market is still intact, so when the price decline halts, buyers once again step in and prices begin to move higher.

At approximately the level of the first top, the longs looking for a short-term profit become particularly sensitive to the price action because they remember what occurred the last time prices were up at these levels.

Longer-term traders who failed to take profits when prices formed the first top and sat through the entire correction are likely to be watching more closely now that the market has come back up to its prior high. They won’t let the opportunity to cash in slip so easily through their fingers this second time around.

There are also the ever-present potential short sellers, who are trying to pick the top, by selling the proverbial high of the move.

When prices penetrate the reaction low (A) that was between the two tops, all recent buyers will have paper losses and sooner or later will be potential sellers. Once prices fail to mount any sustainable rally, hope begins to wane and liquidation of long contracts becomes an inevitable reality. As prices fall with increasing acceleration, new shorts also enter the market.

This type of topping action is typical in a bull market and is where the proverbial phrase “a bull market dies under its own weight” is coined. Send us your questions or comments about this article and chart.

— 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.

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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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