Channels Inside Channels

06/06/02 06:10:18 PM

by David Penn

Does the development of a higher channel inside a trend channel suggest a break to the upside in commodities?

Security: $DXY, $CRB
Position: N/A

In other articles for Working-Money.com and Traders.com Advantage, I've discussed the phenomenon of chart patterns following chart patterns. One of the best examples of this has been in the U.S. dollar, which formed a bearish descending triangle-like top in March and April and a bearish flag in early May. These two chart patterns chronicled the U.S. Dollar Index's drop from just under 120 to just under 111 in three months.

As should be expected, the U.S. Dollar Index's losses have been the CRB Index's gains. While the greenback went from 120 to 111, the CRB during the same time frame climbed from 192 to 204.

Figure 1: Patterns following patterns: A descending triangle and bearish flag take the dollar down.

Disregarding for the moment the spike in the CRB that took the index as high as 210, the most interesting aspect of the CRB's advance is the trend channel that has characterized the rally from April into June. Trend channels can be helpful ways of monitoring the development of a trend, particularly insofar as the bottommost line connecting the lows is often a source of support, while the topmost line connecting the highs is often a source of resistance. Note how the April and May rallies both stall at the top of the trend channel. Similarly, the correction in the second half of April going into May stops just under 199, where the trend channel provides support.

Figure 2: Prices shifting to the upper end of this trend channel may anticipate an upside breakout.

Graphic provided by: TradeStation.

Trend channels, like trends, do not go on forever. Sooner or later, prices break through the channel, providing a strong indication that a trend may be intensifying (moving upward or downward at a sharper degree), moderating into a sideways consolidation, or reversing. The fact that the CRB appears to have moved into a new, higher trend channel based on the correction lows in May and June strongly suggests that the CRB price break will be on the upside. This process is really little more than price action making higher lows. This, accompanied with the rising resistance trendline that marks the higher highs, generally suggests rising prices over the immediate term.

What the new higher trend channel also provides is an additional measure of support for CRB bulls. Now, instead of needing the CRB to break the lower trend channel line to suggest that the uptrend may be running out of steam, commodities bulls have a second higher level of support that, if violated on the downside, could alert cautious traders that the CRB advance is perhaps not as strong has it has seemed this spring.

On that note, the CRB is moving into an area of some consolidation (mid-March was largely a rest stop on the CRB's way up to its year-to-date peak of 210) between 203 and 205. This suggests that the CRB may not move upward in June as quickly as it has in May. Nevertheless, the trend remains upward and as long as the lower trendline for the new, higher trend channel remains unbroken, the year-to-date highs of 210 will be there for the taking.

David Penn

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

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