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DOUBLE BOTTOMS


Cocoa's Double Bottom

08/22/03 01:06:03 PM
by David Penn

After falling over eight hundred points from its January peak, cocoa looks ready to rally.

Security:   CCU3
Position:   N/A

When I last wrote about cocoa ("Cocoa's Descending Triangle," Traders.com Advantage, March 14, 2003) the outlook for this commodity was decidedly bearish. After rallying as high as 2300 in January (and this as part of an attempt to take out the previous high around 2325 registered in October), cocoa futures (basis September) suffered a high volume, gap breakdown that sent prices plummeting. Although consolidating during the spring between, roughly 1990 and 1800, cocoa prices again broke down in April and continued falling until the early summer, at their lowest point reaching 1420 for a six-month decline of 38%--a colossal bear market, especially for a commodity. Back in March, I warned that cocoa was likely to take out the November lows. That it has -- and then some.

However, cocoa futures have since formed a base, roughly between mid-May and mid-August, from which a significant rebound in cocoa prices seems to be increasingly likely. This is suggested largely by way of the double bottom shape this base has taken. After making a low at 1420 in May, cocoa futures rallied as high as 1657 by late June before slipping back as July began. During July, cocoa futures retreated to precisely the level of the May lows, where they found support and have been rallying ever since.

A successful double bottom in September cocoa could send prices as high as 1940.
Graphic provided by: TradeStation.
 
The upside potential of this double bottom is underscored by the positive divergence in the moving average convergence/divergence (MACD) indicator. Note that while prices for cocoa futures made troughs of equal depth in June and late July (both declines bottoming at 1420), the MACD troughs during the same time periods registered a higher trough in July compared to the one in June. When an indicator provides a bullish signal at the same time that price action is either bearish or neutral, then a positive divergence has occurred.

Positive divergences can often result in prices exploding to the upside, as has been the case with cocoa since it began moving up sharply in mid-August. This move to the upside, in fact, has been so strong that some hesitation (or outright pullback) should probably be expected as prices near a potential breakout level at 1680. Should prices actually break through resistance at 1680, there might be a relatively smooth ride until the next resistance appears in the form of the spring lows around 1800. Resistance here, should it materialize, might be limited however. The measurement rule for double bottoms -- a variation of Stan Weinstein's swing rule -- adds the value of the formation size to the value at the top of the double bottom pattern, a calculation that yields an upside projection of 1940 in an initial move.



David Penn

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

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