Live cattle futures plummeted $23 per hundredweight after turning down from a new historical high in late November 2014.
As always, the news was incredibly bullish at the top, so some livestock producers may have been caught off guard by the sudden drop in prices. However, producers who study charting and technical analysis may have noticed the price action forewarning of an impending downturn.
Technical analysis has the ability to cut through the news. When the trained eye picks up on reversal patterns, indicating a change in direction, this presents opportunity.
Market tops can materialize in a very short period of time and the subsequent downturn predominantly occurs more quickly than the move up. This is because a bull market needs to be fuelled by a constant flow of bullish news. However, a bull market dies under its own weight without being fed any news.
Initially, the market goes down on long liquidation. The selling picks up when the longs decide to get out of their positions, first to protect profits and then to cut losses. Declining open interest provides evidence of this. The open interest is illustrated at the bottom of the accompanying chart. Open interest is the sum of all the long or short futures contracts at the end of each trading session. You will notice, the open interest has been declining with the downturn.
One of the unique aspects of charting and technical analysis is the ability to gain an insight as to when a market is about to turn down.
Reversals are price events that tend to signify turns of minor or intermediate importance. However, when a reversal occurs at new contract highs, arrives after a rather extensive move up both in time and price, and is accompanied by a close lower than the previous week’s low price, this special case becomes a key reversal. Here, the turn in the market could take on more significant meaning than just a minor trend change.
As an indicator of reliability, the week’s trading range, which is the difference between the high and low price, should be wide and the market should first advance into new highs prior to reversing direction and closing poorly.
At a top, a key reversal begins with prices reaching a new high for the current move. The market rather suddenly encounters a large supply of contracts for sale which initially halts the price advance. The buying fails to absorb this heavy selling and prices begin to weaken.
During the same session the selling moves down to the market, creating more pressure. When prices fall below the previous week’s closing level, additional selling materializes.
Thus, after advancing to new highs, the market ends the week lower, often substantially below than the previous week’s close. The initial selling which caps the advance is predominantly by large market participants. The selling which occurs after prices weaken reflects smaller speculative longs getting out.
A key reversal is a complete change in sentiment. As the market starts the week on a strong note, the longs are comfortable and confident. The market’s performance provides encouragement and reinforces the expectation of greater profits.
However, as the market turns down and settles below the previous week’s low, the immediate outlook for prices is abruptly put in question. Longs respond to weakening prices by exiting the market.
This explains why a market can turn down, all the while the news remains bullish. Therefore, knowledge of charting and technical analysis is one more tool producers can use in order to take advantage of hedging opportunities.
Fortunately, the decline in the Canadian dollar has to some degree been supportive to the price of slaughter animals.
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