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Drozd: Reversal patterns alert cattle producers to market downturn

Cattle markets took a sudden downturn in October 2014, catching many producers off guard

The live cattle market has been under pressure since the nearby futures market at the CME peaked at $171.975 per hundredweight in October 2014. In the 14 months that followed, prices on the weekly nearby live cattle futures chart plummeted $55/cwt to $116.975/cwt, before recovering $20 per hundredweight.

Although the downturn was sudden, and may have caught some livestock producers off guard, there were reversal patterns at each market reaction that alerted producers to timely selling/hedging opportunities just before the next price decline.

Reversal patterns occur with frequency in the futures market. Reversal patterns on the daily, weekly and monthly charts are price events forecasting a change in market direction. They generally signify turns of minor or intermediate importance. However, when they appear as part of larger, more important reversal formations, their significance is greatly enhanced as a leading indicator of an impending major change in trend.

I have identified six reversal patterns in the accompanying chart. The first formation, occurring at the height of the rally, was a two-week reversal. However, this two-week reversal occurred at a new high, arrived after a rather extensive move up in both time and price, and was accompanied by a close lower than the previous week’s low price, so this is known as a key reversal. Thus, the turn in the market took on a more significant meaning than just a minor trend change.

A key reversal is a classic chart formation, often seen at market tops. In this example, the key reversal signalled an end to the five-year bull market rally in the cattle futures, which began from a low of $78.70 in December 2009.

The second reversal pattern, which occurred on the first reaction to the downturn was a two-week reversal.

Two-week reversal

A two-week reversal develops when a market rallies to a new high and closes higher for the week. The following week, prices open unchanged to slightly higher, but fail to advance much further before selling appears early in the week to halt the rally and prices begin to erode. By week’s end, the market drops to or below the preceding week’s low and settles lower.

Market psychology

The two-week reversal is a dramatic shift in attitude. On the first week, the longs are confident the market is going higher. The second week is a complete turnaround from the preceding week, as the immediate outlook for prices is abruptly put in question. With confidence shaken and the outlook uncertain, the longs respond to weakening prices by exiting the market; first to lock in profits and then to limit losses.

The third reversal pattern (sell signal) is referred to as an OOPS. This methodology was coined by Larry Williams, a recognized commodity trader of our time. An OOPS occurs when a market opens higher than the previous period, creating a gap, and then turns down and fills the gap. In our illustration, the market gapped higher on the week’s opening and then turned down, filled the gap and thus provided the sell signal (reversal pattern).

The OOPS signal is based on a psychological component. On bullish news, the market gaps higher on the opening, but there is no momentum or follow-through action, so prices reverse. If a trader gets suckered into bullish news and buys, once the market heads lower, they would sell that position. That is the force that drives prices to move lower.

The fourth reversal pattern was another two-week reversal. The fifth and sixth reversal patterns that alerted producers to a downturn were once again the OOPS.

Identifying reversal patterns on the daily, weekly and monthly charts can prove to be advantageous in knowing when to sell or hedge before a market turns down.

Send your questions or comments about this article and chart to [email protected].

About the author

Columnist

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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