Wither Wheat?

10/26/00 09:43:44 AM

by David Penn

A pair of four-month long trading ranges have characterized the December wheat contract for most of 2000. Is a breakout likely here at the bottom?

Security: N/A
Position: N/A

Over the course of 2000, December wheat has traded in two main areas: a spring range between $2.90 and $3.10 per bushel, and a summer-autumn range between $2.50 and $2.70. The drop from the higher, early range to the lower current range took place at the end of June, when two trading sessions took wheat from $3.00 per bushel down to $2.70. That lower figure has served as a fairly effective resistance area, considering that since then the price of December wheat has rarely closed above $2.70.

However, the most recent upside crossing of the $2.70 resistance area happened at the beginning of October and, combined with the early September high and the highs at the beginning of the summer-autumn trading range in early July, have begun to form a series of rising, intermediate highs. At the same time, a string of lows starting with the lows of late July and early August, as well as the lows of mid-September, reveal a pattern of declining lows. While not at all conclusive at this point, the pattern of rising highs and declining lows is reminiscent of the sort of broadening formations that can occur at market tops and bottoms.

Graphic provided by: Barcharts.com.

Playing December wheat as a nascent broadening formation, however, would require stronger evidence in support of the pattern. This evidence, in part, could come in the form of December wheat reaching $2.40 per bushel--which would almost certainly establish a broadening formation of higher highs and lower lows. As a bottom formation--and wheat has been trading along the bottom of its price range all year--broadening patterns are usually more indicative of price rallies than further declines. Yet because broadening patterns as a whole tend to be bearish formations, the best way to approach a potential broadening bottom is to wait for an upside breakout or price close above the highest high in the formation. Thus, December wheat would need to continue retreating to the $2.40 area, then rally 40 cents to close above $2.80 per bushel in order to complete the formation and, perhaps, develop further progress on the upside.

Full-fledged broadening bottom or no, the current price action is keeping December wheat from settling more comfortably into a 20 cents trading range. There are two upside breakouts (late August and late September) that violate the range, and one downside breakout (mid-September). And what is interesting from the point of view of trading within the range is the price reaction when the trading range is breached. In this case, playing December wheat as a trading range would first require identifying that range--which appears to be between $2.50 and $2.70 per bushel. Second, note that December wheat breached the trading range three times, with the subsequent reactions being 21 cents, 25 cents and--to date--about 21 cents. Lastly, such a strategy would involve going short when prices reached the top end of the range (about $2.70) and going long when prices reached the bottom end of the range (about $2.50).

There are risks involved in playing December wheat's current trading range. A similar strategy deployed against the contract's spring range (between $2.90 and $3.10), a strategy that relied on downside penetration of the $2.90 mark and upside penetration of the $3.10 mark would have realized a number of small, profitable trades in March and April. The biggest gains, however, would have been realized during the late April going into May advance, the late May to mid-June decline, the late June to early July advance, and the big early July to mid-July decline that brought prices to their current trading area. But there is no guarantee that the present trading range will afford traders the same opportunities--particularly with the increasing volatility in prices. A short, for example, at the most recent upside breakout at $2.70 would have had to withstand three above $2.75 closes before prices retreated. As of this writing, however, the short would have been rewarded: December wheat closed just under $2.60.

David Penn

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

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