Corn futures at the Chicago Board of Trade rallied to a nine-month high in April 2016. The 55-cent-per-bushel gain may have come as a surprise to some market participants, given USDA is forecasting global corn ending stocks to be record large in 2015-16.
However, there were signs the market had stopped going down, at least in the short term. The first clue was the development of a two-week reversal, which is illustrated in the accompanying chart.
A short-covering rally quickly ensued amidst the bearish fundamentals. A short-covering rally kicks in when the shorts, futures traders who are expecting prices to go down, find prices strengthening. At first the shorts buy back their positions to protect profits and then to cut losses.
The market accelerated higher when buy stops were triggered above $3.74. This was an area of resistance on the weekly nearby corn futures chart that coincided with the upper boundary of a rectangular pattern. The lower boundary was defined by the horizontal line at $3.47.
Once prices exceeded $3.74, the market quickly rallied to $4.01, which was the objective derived by extending the rectangle’s 27-cent trading range beyond the breakout point.Rectangles
In the majority of cases, rectangles prove to be continuation or sideways consolidation patterns in which prices having been in an obvious trend will pause for several weeks without making progress. The market may be digesting its advance or decline. Less than one-third of the time, this formation will evolve into a legitimate trend reversal. As a general rule, rectangles as reversal patterns are most likely to occur weeks after a downtrend. Thus, they form a bottom prior to the start of a new advance.
A rectangle formation consists of a trading range, which is bounded on both the top and bottom by horizontal lines (see attached chart). Within this range, the price fluctuations must form at least two tops and bottoms. Volume will normally taper off as the rectangle lengthens in time. The pattern reaches completion when the price exceeds either the upper or lower boundary.
The breakout from a rectangle is considered to be a reliable forecasting tool. A minimum measurement is determined by the vertical distance of the rectangle projected at the point of breakout.
Since the rectangle basically outlines a trading range, the buying and selling which comprises this pattern denotes support and resistance levels within the current price trend. In our example, a downtrend was in progress. The lower horizontal boundary begins to form due to profit-taking by shorts, which turns prices higher and attracts bargain hunters. The upper boundary represents a line of resistance where the supply of contracts for sale exceeds the demand, or buying of contracts.
Between these two extremes the market is in relative balance, with neither buyers nor sellers able to gain a lasting advantage.
Prices remain trendless for a time until either the buying at the upper boundary exceeds the selling, or the selling at the lower boundary exceeds the buying. When either occurs the scales are tipped and prices break out of the formation.
When a rectangle develops in a downtrending market, one should realize that a breakout through the upper boundary not only cleans out the supply of contracts which had previously halted the advance, but it puts all shorts into a losing position. Similarly, in an uptrend, when prices break through the lower boundary of this formation all longs are placed on the defensive. To understand where on a chart the anxiety level of shorts or longs increases is very useful for it is shortly thereafter that their contracts become fuel for the fire.
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