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REVERSAL


Cotton Comes Down

04/01/05 11:34:04 AM
by David Penn

A 2B top anticipates a reversal in cotton futures.

Security:   CTN5
Position:   N/A

There's nothing better than coming back to a commodity whose charts you haven't looked at regularly in a while, only to find those charts featuring one of your favorite setups or patterns.

That was pretty much the case when I took a look at cotton futures late yesterday afternoon. With all the talk of inflationary fears and commodity prices exploding to the upside, I thought it might be worthwhile to take a look at some of the less-discussed commodities to see how they are faring in this allegedly proto-inflationary environment (see my recent Traders.com Advantage articles, "Crude's High Altitude 2B Top," and "Will A Head and Shoulders Top Stop The Bean Meal Bull?" from March 25 and 28, respectively).

Figure 1: The 2B. Reversal or pullback, the 2B top method provides insights for longer-term traders and opportunities for those trading in a shorter time frame.
Graphic provided by: Prophet Financial, Inc.
 
The 2B top (or 2B bottom, for that matter) is the observation by Victor Sperandeo (METHODS OF A WALL STREET MASTER and PRINCIPLES OF PROFESSIONAL SPECULATION) that new highs (or lows) that do not show followthrough after an extended trend are often bull (or bear) traps. Whether these traps lead to reversals or mere pullbacks/bounces, Sperandeo's 2B methodology is a nice tool not only for top-ticking and bottom-fishing traders, but also for traders and investors in general who need to know if the chances of a trend ending have increased significantly.

The case of July cotton is instructive. It is impossible to know if the current slide in cotton prices represents a reversal and a new bear move down, or simply a pullback and accumulation opportunity for savvy traders looking to profit from a renewed push higher. But the 2B test did accurately anticipate weakness.


Note how July cotton made a high on March 16, pulled back, then set a higher high on March 28. The 2B test of top suggests that if prices didn't push higher after March 28, then the opportunity for a reversal--short term or not--was great. The following day, July cotton opened higher, but was unable to sustain those highs. The 2B test of top now suggested that there was an opportunity to the short side if prices--in addition to failing to sustain the highs--moved below the low of the initial higher high back on March 16.

This is precisely what July cotton did on March 30.


One trick with actually trading 2B tests of top and bottom is this: how far below the initial high (the March 16th high in this instance) should the trader look for an entry? A few ticks? A few points? I've gotten into the habit of using half the range of key days as a "spacer" to help minimize getting ticked into trades, only to be immediately reversed out. Such a technique would have come in handy here. Consider: the range on the key day of March 16 was about 1.18 cents. Divide that amount in half and subtract it from the low of the day. That provides a short entry at about 53.73. Unlike the trader who used the low of March 16 as the short entry point, the trader who used this approach would have avoided the brief reaction to the upside on March 31 (a reaction that would have cost about 83 cents), and still been filled on April 1.

As of this writing, in either event, both 2B top traders would be nicely in the money.




David Penn

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

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Date: 04/01/05Rank: 2Comment: 
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