The nearby MGEX spring wheat futures have been stuck in a US$.60-per-bushel trading range since July 2015. Prices have thus far been unable to exceed resistance in the US$5.42 area, as the selling overcomes the buying.
Subsequently, the US$4.82 level is proving to be support, an area where the buying picks up and the market begins to turn back up.
This sideways trading range has developed into a rectangle formation. Rectangles are important to note, as they provide a measurement of how far a market will move in the direction of the breakout.
Rectangles, or box formations as they are sometimes called, are found frequently on futures price charts. In the majority of cases they prove to be continuation or sideways consolidation patterns in which prices, having been in an obvious trend, will pause for several weeks without making progress.
In the example I am using in the accompanying chart, the market is digesting its decline. The MGEX spring wheat weekly nearby futures have been in a sideways, US$.60-per-bushel trading range for the past 16 months. 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 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 chart at top of page). 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 highly reliable as a forecasting tool. A minimum measurement is determined by the vertical distance of the rectangle projected at the point of breakout.
Rectangle completion can be premature, as prices will sometimes exceed the formation’s boundary only to return to the pattern before moving in the direction of the original breakout.
Since the rectangle basically outlines a trading range, the buying and selling behaviour which comprises this pattern denotes support and resistance levels within the current price trend.
Assuming the market is moving higher, the upper horizontal boundary begins to form due to profit-taking by longs, which turns prices lower. As occurs in other patterns, this decline attracts bargain hunters. The lower boundary represents a line of support where the demand, or buying of contracts, exceeds the supply. Similarly, 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.
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 a downtrend, 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.
Wheat producers who were selling wheat as the nearby futures approached the area of resistance at US$5.42 were able to avoid having to sell at the market lows.
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