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OVERBOUGHT OVERSOLD


Summertime ... And The Cotton Is Slipping ...

07/25/05 12:52:31 PM
by David Penn

Do oversold readings in October cotton make the case for value--or merely further declines?

Security:   CTV5
Position:   N/A

The fish might be jumpin', but the cotton is anything but high. At least not as far as cotton futures are concerned. Who knows what is pressuring cotton. One guess might be the threat of a free-trade agreement that would include ending price supports for American cotton farmers. The Guardian newspaper reported recently that American cotton farmers receive more than three billion dollars a year in subsidies that allegedly encourage overproduction and chronically weak prices for the commodity--a staple export of many developing nations such as Pakistan and Mali.

Interesting--but another reason why I prefer technicals to fundamentals. None of the above explains why cotton prices are particularly weak now.

Figure 1: The last time October cotton became oversold (basis stochastic) it lost about three cents before that oversold condition ended a month later. Each cent in cotton futures is worth $500.
Graphic provided by: Prophet Financial, Inc.
 
That said, cotton has juked me more than once in 2005. In early April, a 2B test of top ("Cotton Comes Down," Traders.com Advantage; April 1, 2005) suggested lower prices, then late in April, an ascending triangle ("July Cotton's Ascending Triangle Breakout," Traders.com Advantage; April 26, 2005) suggested that, no, higher prices for cotton were in store.

The "tie" went to the bears this time, as the breakout from that ascending triangle failed, sending cotton prices into an abrupt reversal. For the next six weeks cotton futures continued to retreat, becoming oversold in mid-May and remaining so until mid-June (three cents and some $1500 later). A positive stochastic divergence that had been developing since mid-May finally resulted in a bounce in mid-June as well, sending cotton futures on a quick five-cent ride higher going into earliest July.

But the bear, as they say, is back. In a little over two weeks the bears in October cotton have taken back those five cents and then some, sending the futures down below the closing lows of June. This time, not only has October cotton become oversold, but prices have also begun to drag down the lower band of the long-term Bollinger Bands. This could be significant for two reasons. First, if the Bollinger Bands expand over the next several weeks relative to the compression of June, then October cotton should see the kind of volatility that truly makes a commodity worth trading. Second, the fact that it is the lower Bollinger Band (and, again, a longer-term Bollinger Band based on the 80-bar EMA rather than the standard 20-bar) that is being "bent" lower suggests strongly that any volatility in the near-term will more likely take prices lower rather than higher.



David Penn

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

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Date: 07/26/05Rank: 2Comment: 
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