Watch for rising wedges in bear markets and falling wedges in bull markets, where they are most apt to occur
Red spring wheat grading No. 1 13.5 per cent protein reached $8 per bushel for the 2012-13 crop year. This is the highest price farmers have been able to lock in, since the open-market era was announced in mid-December 2011.
True to form, wheat prices began their seasonal turn higher, just as the U.S. winter wheat harvest approached its midpoint. Also not surprising was the fact wheat prices put in a contract low just before turning back up.
Technically, spring wheat prices on the December 2012 MGEX futures contract exceeded the upper boundary of a falling wedge in May 2012. Prices then had a downward correction, held support, and reversed back up after a two-day reversal (buy signal) materialized on June 14. Spring wheat prices quickly gained $1.12 per bushel in the following 10-day period, with prices achieving the falling wedge objective of $8.32 per bushel.
A wedge is an upward or downward slanting formation which contains all price activity between its converging boundaries. The essential feature distinguishing a wedge from any of the various triangle formations is the accentuated slope of the pattern.
Wedges are classified as either rising or falling (sloping up or down). The wedge pattern implies a minor or intermediate turn. A rising wedge occurring in a major downtrend is bearish.
Conversely, a falling wedge is bullish. The pattern is completed when prices break out from their converging boundaries. For a rising wedge this means a decline through its lower boundary and for the falling wedge it’s an advance through its upper boundary. Wedges occur with a fair degree of frequency in the futures markets.
One should be on the alert for rising wedges in bear markets and falling wedges in bull markets, as this is where they are most apt to occur and are most reliable.
As a rule, after the pattern is completed prices should retrace all of the vertical movement comprising the wedge. This is reflected in the accompanying chart, with the recent rally back up to $8.32 per bushel.
Often, wedges will begin with a high-volume day marking at least a temporary end to the current price move. In the case of a falling wedge, which is illustrated in the accompanying chart, this move will have been up. Typically, the market’s rally has had the speculative shorts on the run. The wedge begins to form as their buying exodus peaks.
With the weakest shorts now out, additional buying pressure at prevailing prices is absent. All remaining shorts in the market have made the financial and psychological commitment to at least hold for a downturn. With buying abated, prices begin to slip lower.
Progress is slow but the pattern is clear as prices put in a series of lower minor highs and lows. At first, normal profit-taking by the longs triggers the decline, but soon hedgers and short speculators make their presence felt by selling on the now small bounces in price. The market’s inability to rally to higher minor highs attracts additional sellers.
Highs begin to erode faster than the lows, giving the pattern its narrowing shape. The converging boundaries of the wedge signify its limited duration. Speculative selling continues to erode the market, but volume fails to grow, which is a reason for caution.
There is no great quantity of contracts for sale above the market, so each time the selling diminishes the market is able to bounce back up. The decline will progressively gain less ground until all the potential sellers have been satisfied. At this point, instead of simply backing off, the market longs begin to go bargain hunting. New longs, as well as existing shorts now comprise the buyers.
A penetration of the upper boundary of the falling wedge (point A), confirms the breakout and resumption of the uptrend. Thanks to the falling wedge objective, farmers and traders alike were able to anticipate the recent rally to $8.32.
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