May Coffee's 2B Test

04/07/03 11:59:16 AM

by David Penn

Does a short-term 2B test of bottom anticipate an upswing in coffee futures?

Security: KCK03
Position: N/A

There has been a bear market in coffee for longer than there has been a bear market in stocks. Perhaps, with fewer, red-eyed day traders in the market and fewer dot-com dynamos working around the clock to bring profit-free companies public, the demand for coffee has slackened. Whatever the reason may be for the decline, coffee futures have been a trend traders dream to the short side. Basis continuous futures, coffee has fallen some 80% since its 1997 highs.

But the action in coffee futures in 2002 and 2003 to date is enough to make traders wonder whether or not a bottom in coffee might be imminent. One case for a bottom in coffee is built on the higher low coffee futures made in the first quarter of 2003 (this in contrast to the lower low in the fourth quarter of 2002). A second case for a bullish turnaround (or even an end to the multi-year decline), comes from the fact that coffee is entering an area of historic price support from 1996 lows. However, the most immediate case for a turnaround in coffee comes from its current 2B test of bottom.

Rising momentum and a close above the 20-day moving average are both bullish for coffee futures.

Graphic provided by: TradeStation.

The 2B test of bottom states essentially that whenever a market makes a low, rallies, then makes a lower low, any inability to follow-through immediately to the downside is reason to suspect that a low of some degree has been made. The inability to follow-through on the downside is not a guarantee that the market in question will rally. But it does suggest that the risks involved have shifted such that a trader could conceivably initiate a long trade with the assurance that he or she will know very quickly whether or not that trade was the correct one.

Here, in the case of May coffee, the futures put in an intraday low of 57.25 on March 18th. From this point, May coffee rallied for a few days, then fell, marking a lower CLOSING low of 57.15 on March 27th (the intraday low was 57). This sets up the first part of the 2B test of bottom. The second part comes as coffee prices, instead of following-through with more on the downside, actually rallied, closing above 60 with the highest close in seven days. May coffee also moved above its 20-day moving average as part of this rally.

As the trio of moving averages shows (they are the 20-day, 50-day and 200-day simple moving averages), there remains some resistance at 63. Actually, the fact that both the 50- and 200-day moving averages are roughly at the same 63 level makes for exceptional resistance to any continued advance in coffee futures. Even though the momentum indicator provided here suggests that there is more upside for coffee, it will be worth watching to see how this indicator reacts as coffee futures approach the 63 level.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine, Working-Money.com, and Traders.com Advantage.

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