A Head (And Shoulders) Of Cattle

11/04/04 08:12:38 AM

by David Penn

A nearly five-month topping pattern in December live cattle futures looks set to resolve itself in a breakdown.

Security: LCZ4
Position: N/A

Is the head and shoulders pattern the king of technical patterns? Writing in their classic technical analysis tome, TECHNICAL ANALYSIS OF STOCK TRENDS, authors Robert Edwards and John Magee note of the head and shoulders pattern: "This is one of the more common and, by all odds, the most reliable of the major reversal patterns." Given the role that this book has played in shaping the opinions of a generation of technical analysts, Edwards and Magee's comments represent quite an endorsement.

If the H&S top is the king, then the December live cattle futures contract (LCZ4) may be its kingdom. After a low near the 72-cent level back in December 2003, LCZ4 embarked upon a strong bull market that saw it rally to above the 92-cent level by mid-summer 2004. However, by the time December cattle broke into the 90s, the contract was already beginning to carve out the familiar peak/higher peak/peak pattern of the head and shoulders top.

Figure 1: After an eight-month rally, December live cattle futures have created a consolidation range that looks very much like a head and shoulders top. Note the powerful volume surge in late October as prices break down below the neckline at 85 cents.

Graphic provided by: Prophet Financial, Inc.

As Edwards and Magee noted, big volume on the pattern break is key. And a look at the December live cattle futures contract at the end of October shows just that sort of big volume as price drop below neckline support.

What sort of downside might take place here if December live cattle's breakdown remains successful? Given the height of the head and shoulders pattern at its tallest point (approximately 6.60 cents) and subtracting that amount from the value at the neckline (85.35) gives a downside minimum objective of 78.75.

Interestingly, a decline to the 78.75-cent level would send December live cattle futures back to the consolidation area of the spring of earlier in the year. Support at this level should help stem any breakdown -- possibly making the minimum objective the objective.

David Penn

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

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A Head (And Shoulders) Of Cattle

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