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Is Coffee Creeping Lower?

10/20/06 03:44:08 PM
by David Penn

A descending triangle is one hint that a test of the lows is likely.

Security:   KCZ6
Position:   N/A

If you haven't found many recent arguments in favor of higher coffee prices to be convincing, then that might have something to do with the fact that coffee prices have not been moving higher.

FIGURE 1: DECEMBER COFFEE FUTURES, DAILY. This descending triangle suggests another leg down in KCZ6. As long as the series of lower highs that began in August continue, selling pressure is likely to result in a push down below support at the 101–102 area.
Graphic provided by: Prophet Financial, Inc.
I last wrote about coffee in February 2006 -- making a probably forgettable point about the potential for a bounce based on patterns in the hourly chart of the July contract. At the time -- mid-February 2006 -- coffee had tumbled approximately 20 cents from its January high. Looking to the hourly charts for early signs of potential support and a possible bounce, I found a pair of positive divergences in the moving average convergence/divergence (MACD) histogram and stochastic that hinted at an upside. I wrote:

The divergences on the hourly level suggest that a bottom is in, which means that traders and speculators can set stop-loss levels appropriately based on that bottom. And should that level be exceeded to the downside, traders can prepare themselves for the even steeper declines that are likely to follow.

And follow they did. After bouncing to the 117-cent level, coffee futures (basis July) rolled over and set a lower monthly low in March, a lower monthly high in April, and a sizable breakdown below the 105-cent level in May.

FIGURE 2: DECEMBER COFFEE FUTURES, WEEKLY. The low level of trend as suggested by the exceptionally low ADX (in black) is the sort of reading a technician would expect to see in the indicator during a significant consolidation.
Graphic provided by: Prophet Financial, Inc.
Coffee futures eventually seemed to find a bottom in July. Moving to the December contract (Figures 1 and 2), coffee futures bounced around 98 late in the month. Over the course of August the futures moved as high as 113 before slipping into a pattern of, if not lower lows, then at least consistently lower highs in August, September, and now October.

The series of lower lows in December coffee beginning in August are reminiscent of a descending triangle. The "trendline discipline" is very good, with three touches on the downwardly sloping resistance trendline and at least as many on the horizontal support trendline at approximately 102. The size of the triangle -- 11 points at its widest point -- suggests the potential for a breakdown to 91 or worse, should the support line not hold.

Arguably the whipsawing of the bullish DI+ (in green) and bearish DI- (in red) lines -- with the most recent "whip" lashing in the bearish direction with the DI- line overtaking the DI+ line -- provides little directional clues at this point. However, the extreme low level of the average directional movement index (ADX) (in black) is exactly the sort of trendlessness a technician would expect to find in a mature, prebreakout consolidation.

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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Date: 10/20/06Rank: 2Comment: 

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