Each day’s prices and the pattern configurations are a direct result of human decisions to buy and sell
Technical analysis is the study of market movement. Its strength and popularity comes from the assumption that future price direction can be predicted by studying a market’s past activity.
Technical analysis is concerned exclusively with the market and certain statistics the market generates — prices, volume and open interest. In technical analysis, no consideration is given to daily news developments, supply and demand factors, government reports or policies.
These areas are the concern of fundamental analysis, which attempts to identify all factors impacting the supply and demand relationship, weighing each to determine what effect a change in any one factor has on price.
Over the longer term, major changes in supply and demand and in government policies do determine the direction of futures prices. However, over the short and intermediate term, technicians will argue that this is a difficult task requiring almost perfect knowledge, which renders fundamental price forecasting (at least in the short term) an exercise in futility.
Market participants often get caught looking up at the top because the fundamental news is always the most bullish at the top. This is when traders hear of the lowest yields, the phenomenal demand and the tightest ending stocks. The fact is high prices bring out the bullish news in a bull market.
Technical analysis is committed to the theory that the market itself simply and efficiently discounts all fundamental factors each and every day. I have found that charting and technical analysis has the ability to cut through the news, and this is why disciplined traders focus on the charts for catching market turns.
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 is an indirect examination of human nature in the marketplace. A primary objective in using charts is to recognize these patterns when they begin to take shape.
Reversal patterns develop at the end of an existing trend and, upon completion, indicate the trend has turned. When a reversal pattern occurs at a new historical high, it takes on a greater degree of prominence.
On Monday September 4, 2012, prices on the daily nearby soybean meal chart (September 2012 futures contract) developed a reversal pattern (sell signal) called a key reversal from a new historical high of $554.40 per ton.
Prices quickly sold off and by week’s end a two-week reversal materialized. This pattern is illustrated in the accompanying soybean meal chart. I now anticipate that at the end of September, a two-month reversal will develop on the monthly nearby chart.
This is a classic example of topping action, when a reversal pattern first appears on a daily chart and is followed by reversal patterns on the weekly and monthly charts.
On the first week, the market advances to a new high for the rally and settles near the high of the week. On the second week, prices open unchanged to slightly higher but cannot make additional upside progress. The advance stalls, as selling increases and prices begin to erode. By week’s end, the market drops to around the preceding week’s low.
The two-week reversal reflects a sudden change in sentiment. On the first week the longs are comfortable and confident, as the ensuing rally provides the expectation for greater profits.
However, the second week’s activity is a complete turnaround from the preceding week, which shakes the confidence of all those who are still long the market. The immediate outlook for prices is put in question. Longs respond to weakening prices by exiting (selling) the market.
By understanding the psychology of the market, and by watching for reversal patterns, technical analysis can prove to be a useful tool for livestock producers, when it comes to hedging their meal requirements.
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