A Breakout In Coffee

01/09/06 08:46:32 AM

by David Penn

I like my coffee the way I like my breakouts: "Strong as the devil and sweet as love."

Security: KCH6, KC
Position: N/A

The Brazilians say that coffee should be "strong as the devil, as black as ink, as hot as hell, and as sweet as love." The Turks claim as an ancient proverb the notion that coffee should be "black as hell and strong as death" in addition to being "sweet as love."

FIGURE 1: MARCH COFFEE, DAILY. The higher low in December was a fundamental signal that coffee futures were more likely to continue higher than lower. Stan Weinstein's swing rule suggests an upside to $1.22 per ounce.

Graphic provided by: Prophet Financial, Inc.

So that's the way the Brazilians and Turks like their coffee. But how do they like their breakouts?

I wrote about the bull market in coffee a few months ago for Traders.com Advantage ("The Parable Of Coffee And The Blind Traders," September 2, 2005). The upshot of that article was in the subhead: "The end of a downtrend and the resumption of an uptrend loom in coffee futures." More specifically, I noted how the bear market in coffee futures that lasted for much of 2005 -- a bear market that took coffee prices from near $1.40 a pound in March to under $1.00 by late August (basis continuous futures) -- was really just a correction in a much larger bull market in coffee futures. (See Figure 1.) That larger bull market extends back to the lows of late 2001, when coffee was closer to 40 cents a pound.

Price action in this multiyear bull move in coffee futures was contained by a trend channel up until a breakout in late 2004 -- the 2005 correction, again, being largely a retracement of that channel breakout (see Figure 1). The correction saw coffee slip back into its trend channel over the summer of 2005, but recent price action has coffee bounding back outside the channel. From the perspective of that trend channel, it will be worth watching to see if the upper boundary of that channel -- again penetrated -- will serve as a source of support for any further pullbacks in coffee (Figure 2).

FIGURE 2: CONTINUOUS COFFEE FUTURES, WEEKLY. Note how the bottom in the third quarter (July to October) is anticipated both by the MACD histogram and the positive divergence in the stochastic.

Graphic provided by: Prophet Financial, Inc.

I was tempted to call the breakout in March coffee a "cup with handle" breakout. But that would probably be inaccurate. If anything, the pattern might more charitably be described as what Thomas Bulkowski (author of Encylcopedia Of Chart Patterns) calls an "Eve & Eve" double bottom. This refers to a double bottom pattern in which the two bottoms are rounded rather than V-shaped (as is the case with the "Adam & Adam" double bottom). Although the two bottoms aren't at exactly the same level, their respective lows are within the 6% maximum that Bulkowski suggests is preferable for coherent double bottoms.

With a double bottom, the minimum likely upside for the breakout can be anticipated using Stan Weinstein's swing rule -- which is identical in this case to the measurement rule suggested by Bulkowski. Taking the measure of the formation (from $1.12 to 90 cents) and adding the size of the formation to the value at the breakout gives a minimum upside of approximately $1.34. Should this estimate prove accurate, coffee will indeed be "sweet as love" for those bulls fortunate enough to be along for the ride.

David Penn

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

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A Breakout In Coffee

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